Investigation on the Impact of an Energy Desubsidization Shock on the General Price Index Via a Nonlinear Inflation Model: Case of Iran

For decades, energy prices have been controlled by the government inIran. This policy had a long lasting impact on almost all economicvariables in Iran. To date, under tremendous pressure to adequately meetthe huge domestic demands for energy inputs, the government hasdecided to reduce/eliminate the energy subsidies. Thus, its impact on theconsumer price index is unavoidable. This paper investigates thedynamics of that impact via a dynamic nonlinear inflation model. It isshown that an increasing shock in fuel price has less increasing effect onthe general price index, compared to the steady state effect of acontinuously increasing signal. Based on this fact, it is deduced that otherfactors, e.g. the Money Supply Growth and the Goods Market Gap, hasmuch more impact on the inflation. Therefore, unsubsidizing energyprice, particularly fuel, will empower the government to save moremoney and avoid expansionary monetary policies. The currency not usedfor subsidizing fuel price can help to decrease the money supply growth,and contribute subsidence of extremely growing inflation due to themoney gap.