The Impact of Exchange Rate Shokes on Iran’s Income Distribution: A Computable General Equilibrium Model

The exchange rate, as one of the macroeconomic factors, reflects the economic conditions of the country and is the link between domestic and foreign economies. It has a direct impact on the price of exports, imports as well as domestic prices. In the same vein, income is related to household consumption and affects the distribution of household income. Widespread inequalities in income distribution lead to the emergence of poverty and the creation of gaps among the social classes. When poverty is on the rise, it is inevitable to see a decline in the level of health, hygiene, nutrition and education of the people of the society and, consequently, economic productivity, economic growth, production and national income. This vicious circle leads to the aggravation of poverty. Inequality can undermine social cohesion, reduce intergenerational income mobility, and create challenges such as social discontent and political instability.Exchange rate through export prices (assuming the stability of the world export price based on foreign currency) affects economic variables. In this process, the price of a product is determined based upon the export prices and domestic prices. So, with export prices being on the rise, product prices increase. This will increase the price of the producer active in exportation and ultimately the household income. The influence of the exchange rate through the imported prices would be another factor that needs to be taken into consideration. According to such a mechanism, assuming that the world prices of the imported goods are constant, exchange rate fluctuations cause changes in the import prices (based on the national currency) that interact with the price of the domestic demand. It changes the price of composite goods. According to the aformentioned mechanism, it is expected that the increase in the exchange rate will increase the price of composite goods as the import prices increase. In this way, the value added decreases, and the reduced price of production will reduce household income. In general, it can be said that one of the most important ways in which a growing exchange rate affects household income and, consequently, household expenditure and welfare is the exertion of those two forces.

The purpose of this article is to investigate exchange rate shocks on income distribution using a general equilibrium model. The Computable General Equilibrium (CGE) model is a quantitative analysis method that is flexible in the face of a wide range of policy issues and can provide a holistic framework for examining the comprehensive effects of shocks. In addition, the robust micro-framework of general equilibrium models, which fully describes the optimization behavior of economic agents, allows these models to have stronger analytical foundations. General equilibrium models evaluate different economic policies and programs as well as the way of interaction and communication of different economic activities and different institutions in society in different markets. Those models address goods and services, labor market and the outside world in proportional linear and nonlinear forms. Therefore, they are highly able to predict the effects of implementing various socio-economic policies and shocks. The statistical basis of the research is the social account matrix in 2011 published by the Parliamentary Research Center. In this study, the distributive effects of 10, 20, and 30 percent exchange rate increases on income distribution were investigated. To investigate the heterogeneity of households, the parameters of the demand function derived from the Aston Gray utility function were estimated using the income and expenditure data of the Statistics Center of Iran, and then the effect of shocks on income distribution was investigated. Using micro-data on household income and expenditure, the segregation of the household sector in the model increased, and, based on the amount of the household expenditures, the households were classified into ten groups (using the typical middle household method and the integrated method). Then, the data obtained from the household budget studies were combined in the social accounting matrix, and the general equilibrium modeling was performed according to the new databases. Finally, the effect of the exchange rate change on the Gini coefficient was investigated.

As the simulation results showed, increasing the exchange rate from 10% to 30% reduced the average real consumption of urban deciles from 4.94% to 1.76% and, in rural deciles, from 4.57% to 1.15%. This effect was greater in urban households than rural households. It increased the Gini coefficient in both deciles. Also, currency shocks emerged as an important factor in explaining the level of inequality and income gap created between different income deciles. The impact of the currency shocks between urban and rural income deciles was not the same. The above shocks have caused a greater decrease in the level of consumption of urban income deciles than rural income deciles.  This difference in the intensity of response to currency shocks is much greater among the lower income deciles.

Since this article follows the relationship between the devaluation of the national currency and the income distribution of urban and rural households, the following suggestions are made so as to achieve policies that can neutralize the effects of currency shocks on income distribution.- Adopt the right approach by the central bank in managing the foreign exchange market and stabilizing the real exchange rate.- Reduce the country's dependence on the oil sector, import and increase the diversification of export products, and increase the share of the National Development Fund in oil revenues in order to reduce the effects of currency shocks.- Develop the financial sector of the economy. The results show that the more developed the financial markets, the less the effect of exchange rate shocks on income generation and distribution. In this regard, it is recommended that future research use a general equilibrium model instead of partial balances, and the financial sector be considered in the social accounting matrix (FSAM) so that a higher degree of trust can be achieved.