The Impact of Inflation Volatility on the Relationships Between the Iranian Trade Balance with the Exchange Rate: Non-linear Approach

Inflation volatility is one of the characteristics of Iranian economy over the past four decades. Inflation volatility by creating macroeconomic instability can affect the relation of economic variables. The purpose of this study is the evaluation of the impact of nonlinear inflation volatility on the relationships between the Iranian trade balance with the exchange rate during the 1973-2016.
For this purpose, firstly inflation volatility by using EGARCH method has been estimated and the model was estimated by Markov-switching model. The results show that the behavior of trade balance in Iran can be divided in 3 regimes (high, medium and low trade deficit). Increased exchange rate has induced the improvement of trade balance in 3 regimes. The effect of inflation volatility on the relationship of exchange rate to trade balance in the high and medium trade deficit regime is insignificant. Whereas in the regime 3 (low trade balance deficit) is negative and significant. So that in the regime 3(low trade deficit) inflation volatility has caused to debilitation of exchange rate effect on the trade balance and with the increase in inflation volatility exchange rate effect on the trade balance is further debilitation.