By AIC Research Fellow Andrew Lumsden
The term “inflation,” for most, brings to mind images of 1920s Germany or, more recently, Venezuela where the currency has been so devalued that a loaf of bread or a cup of coffee can cost million. Though not to the same degree as in these cases, nearly all economies around the world experience inflation and keeping it in check often requires diligent efforts on the part of governments.
Iran has struggled with relatively high inflation since the late 1970s, but seemed to have been making substantive progress in curtailing inflation during President Rouhani’s first term. However, the United States' monetary policies and its November 2018 re-imposition of economic sanctions has sent Iran’s economy into a tailspin, sending inflation soaring to high levels. What follows is a brief overview of Iran’s experience with high inflation over the past three decades and the ways in which its government and population have reacted to it and how they plan to approach the coming uncertain, potentially difficult years.
● What Is Inflation?
Inflation describes a general, continuous increase in the average prices of goods and services throughout an economy. Accordingly, this leads to erosion of the value, or purchasing power, of a currency. This phenomenon is measured through calculating an inflation rate, which is the percentage increase in average consumer goods prices over a quarterly or annual period. For example, if a country has an annual inflation rate of 10%, this means that at the end of the year one unit of currency would only have the purchasing power which 0.90 units had during the previous year. Between 1980 and 2014, inflation in Iran grew by an annual average of 20%. By contrast, inflation in neighboring Pakistan grew by an average of 8% over the same period and in the United States by 3.22%.
● Why Does It Occur?
There are many explanations for why inflation occurs, but two are at the center of the discussion. The first is called the “demand-pull” theory. This ties inflation to the simple principle of supply and demand. Demand-pull inflation occurs following a larger than necessary infusion of money into an economy. More people have access to more money and seek to buy more goods. If there has been no significant increase in the supply of consumer goods, prices will increase.
Demand-pull inflation can be happen when:
● A government decides to print more money to pay its debts and expenses, which, absent any real economic or productivity growth, leads to higher prices. An example of this was the Confederate States of America, which during the American Civil War, did so to pay debts and military expenses. Although the money supply increased 11-fold between 1861 and 1864, commodity prices increased almost 30-fold over the same period.
● A country experiences a sudden economic boom. An example of this is the 17th century Spanish Empire which suffered crippling inflation and long-term economic instability after its acquisition of vast reserves of gold and silver from North America.
The other primary explanation for inflation is called “cost-push.” This approach attributes inflation to increases in the costs of production, either through wage increases or a rise in the global market price of a critical raw material upon which many segments of an economy rely. For example, if labor unions or governments insist upon higher wages, sellers may pass these costs on to consumers, thus raising prices and potentially causing inflation. Also, a rise in global oil prices is a common cause of inflation growth among economies which are dependent on oil imports. Higher fuel prices can quickly result in rising prices for consumer goods as manufacturing and transportation costs are passed on to buyers. However, cost push inflation can materialize only if monetary policy accommodates cost push factors.
● How Has Inflation Affected Iran In the Past?
o Throughout the 1960s and early 1970s, inflation in Iran was well-checked with rates consistently in the low single-digits. However, the “oil shock” of 1973-1974 would herald the beginning of Iran’s decades-long battle with high inflation. In 1973, the predominantly Arab, Organization of Petroleum Exporting Countries (OPEC), announced that it would be raising the price of oil and embargoing key Western nations in protest of the latter’s support for Israel in the ongoing Yom Kippur War. The embargo ended in early 1974, but oil prices remained significantly higher. While the oil shock sent tremors through economies reliant on oil imports, for producers like Iran, it was a windfall. Tehran’s oil revenue increased nearly 300% in 1974 over the previous year. This rapid infusion of capital however, was only matched with a less than 60% rise in production. This meant that although Iranians enjoyed higher nominal wages and the government invested in new projects, the expanding demand for consumer goods outpaced the supply, thus resulting in price increases which gradually wore down the value of wages. As spiraling inflation stoked discontent and strikes among the working class, Iran’s imperial government responded in part by attempting to raise wages, a move which would be paid for through printing an additional 30 billion rials. This only exacerbated inflation, which has been cited as one of the many causes for the 1979 revolution that ultimately brought down Iran’s monarchical government and gave birth to the current Islamic Republic.
o Inflation continued to worsen in the aftermath of the Iranian Revolution. Although the new Islamic government initially reduced government expenditures and implemented wage and price controls, it faced a new set of economic problems. Nationalization of vast swathes of the economy including large farms and factories led to reduced production due to many experienced, private business owners being replaced by political appointees. Moreover, the revolution caused an exodus of Iran’s wealthy elite and educated professionals. In part because of the November 1979 seizure of the U.S embassy in Tehran, foreign investment dried up and Iran was placed under international economic sanctions. These developments cut off many of the government’s revenue sources leaving serious deficits which were again addressed through simply printing money. Between 1979 and 1980, close to 160 billion rials were entered into circulation, while the country’s GDP decreased by 10% during that same period. Accordingly, consumer prices, and thus inflation, grew. Iran’s inflation rate rose by more than 11% between 1979 and 1980.
o The Iran-Iraq War (1980-1988) further exacerbated Iran’s economic woes. Whereas state policies had caused “demand-pull” inflation, the conflict’s devastation added “cost-push” inflation to the mix as production costs grew and supplies dwindled. Iran’s inflation rate grew by an average of 20% each year during the war. In 1988, when the war ended, Iran’s inflation rate grew to nearly 30%, higher than at any period since the Second World War.
o The death of Ayatollah Ruhollah Khomeini, the Islamic Republic’s inaugural Supreme Leader in June 1989 represented a critical sea change in Iran’s economic progression. Khomeini’s death paved the way for a new group of Iranian leaders with more liberal attitudes towards trade and economic policy. The administration of President Akbar Hashemi Rafsanjani launched a Five-Year Development Plan aimed at postwar reconstruction, curbing inflation, reducing deficits, attracting foreign investment and diversifying the economy. Under the plan, annual inflation, which stood at nearly 30%, was to be reduced to 8.9% by 1993. This would be accomplished in part through scaling back price, wage and import controls, privatization and the establishment of a market-based exchange rate for the Iranian rial.
o The plan had initial success. By 1991, the annual inflation growth rate had slowed to 9%, the lowest since 1986. This progress, unfortunately, would be short lived. Production, export and employment shortfalls, mounting private sector indebtedness and import costs—which more than doubled since the removal of an artificial currency exchange rate—all contributed to skyrocketing consumer prices. By the plan’s end in 1993, annual inflation had reached 24%, well exceeding the target rate.
o The Rafsanjani administration launched a second Five-Year Development Plan in 1995 which involved some privatization and economic liberalization balanced by the retention of price controls. Nevertheless, inflation continued to skyrocket, reaching another post-WWII high of nearly 50% in 1996. Ultimately, falling oil prices, U.S. trade sanctions and political gridlock in Tehran between conservatives and reformists (who won the Presidency in 1997), meant that the Second Plan would be no more successful than its predecessor. By its end in 2000, inflation had increased by an addition 20% over the previous year.
o In 2000, a Third Development Plan was launched. Like its predecessors, it involved liberal reforms, but focused more on achieving specific and realistic goals regarding GDP growth, investment, deficits and consumer prices/inflation. This plan coincided with a period of high global oil prices and good weather, so its exact impact may be difficult to measure. However, the Iranian economy showed signs of improvement between 2000 and 2005. Unemployment fell, GDP grew and annual inflation rates stood at little over 10%, whereas under the previous development plans, inflation was growing twice as fast.
o In 2005, Mahmoud Ahmadinejad was elected President on a conservative populist platform. He called for a rejection of Western approaches to economics and a redistribution of wealth towards low-income families and underdeveloped regions of Iran. Although Ahmadinejad’s economic policies would achieve marginal reductions in income inequality by 2011, they also rekindled high inflation. Ahmadinejad ordered state-run banks to grant large loans to consumers and investors at low interest rates. This had the same impact as printing more currency as more money ended up in the hands of consumers while there was no commensurate increase in production and supply. During the first seven years of Ahmadinejad’s administration, inflation rose by an annual average of about 18%, compared with a rate of 16% under Khatami.
o The situation would only deteriorate, as beginning in 2012, the United States, European Union and United Nations began imposing economic sanctions on Iran over its nuclear program. International sanctions limited much-needed oil revenue, foreign investment and imports. Economic growth slowed, and inflation rose. By the time Ahmadinejad left office in 2013, inflation was growing at a rate of nearly 35%.
● How Has Iran’s Inflation Experienced Changed Under President Rouhani?
Hassan Rouhani was elected President of Iran in 2013 on a platform which included tackling runaway inflation. Upon taking office, the Rouhani administration moved to secure relief from international sanctions by entering negotiations with the so-called P5+1, (the United States, United Kingdom, France, Russia, China and Germany). It also began reforming key Ahmadinejad-era economic policies. State spending was curtailed to reduce deficits, unproductive government programs were ended, broad fuel subsidies were replaced with targeted social welfare programs and currency exchange rates were reformed.
Rouhani’s policy approach showed initial success. By 2014, Iran’s rate of economic growth had reached 4.6%, a significant improvement over 2013’s rate of -0.3%. Growth would further expand after the Joint-Comprehensive Plan of Action (JCPOA), Iran’s deal with the P5+1 which relieved most international sanctions, was signed in 2015. By 2016, Iran experienced an economic growth rate of 13.3%, a 25-year high. Additionally, JCPOA, coupled with Iran’s improving international reputation and economic performance caused the country’s currency, the rial, to appreciate in the international market and the black market. A strengthening currency and economic growth helped to bring down the rate of inflation in Iran, which plummeted nearly 20% in Rouhani’s first year. By 2017, Iran’s annual inflation rate had reached a twenty-six year low of 9%.
Unfortunately, the benefits of Iran’s economic uptick largely failed to reach the country’s working class. New wealth was essentially confined to the automobile and oil sectors, while food prices continued to rise. Furthermore, the predicted surge of post-JCPOA foreign investment failed to materialize, undoubtedly due in large part to remaining U.S. sanctions not covered by the deal and the 2016 election of Donald Trump to the U.S. Presidency. Trump and his party had long been critical of JCPOA and he vowed to withdraw from it if elected.
In July 2018, President Trump announced that the U.S. would no longer recognize JCPOA and would re-impose sanctions on Iran. All sanctions lifted by JCPOA were formally re-introduced in November 2018. The U.S. withdrawal from JCPOA delivered a body blow to an already fragile Iranian economy. The rial’s value has been on the decline since Trump’s announcement, having plummeted by nearly 70% so far this year. Moreover, economic growth is predicted to slump, entering negative territory at the end of 2018, and reach -3.4% by the beginning of 2020. Accordingly, inflation rates are projected to rise 20% by the end of this year, and to 34% by 2019. Worse still, some economists argue that nationwide, average Iranians may experience an actual inflation rate much higher than the official one, with some estimates exceeding 200%.
How have Iranians Reacted to Inflation Over the Years?
Particularly over the past six years, growing numbers of Iranians have responded to inflation by converting their rials into foreign currencies and moving it out of banks, or out of Iran altogether. The imposition of nuclear-related sanctions of Iran in 2012 and the accompanying spike in inflation, sparked a wave of primarily wealthy and middle-class Iranians to convert their rials into U.S. dollars. To escape the watchful eye of their government, many of converting funds tended to bring their money into neighboring Afghanistan for conversion, sometimes with the aid of Afghan middlemen in exchange for a 5%-7% cut. Because monitoring of the flow of money in and out of Afghanistan is poor, the amount of Iranian cash exchanged in Afghanistan is unknown, but it is estimated that some US$4.6 billion in converted funds were flown out of Kabul Airport in 2012 for safe keeping in other countries, primarily in the United Arab Emirates.
Another rush to convert took place in April 2018, when the U.S. sent strong indications that it was preparing to withdraw from JCPOA. These conversions took place largely in Iran itself where crowds of people, panicked about the rial’s recent decline flocked to banks and other financial establishments across the country to convert their cash into foreign currencies. Banks and exchange vendors soon began to run out of U.S. dollars and some suspended exchange services altogether. The Iranian government moved quickly to crack down on this run on the banks. It prohibited the holding of more than 10,000 dollars or euros outside of banks, under penalty of prosecution and sent police to round up unofficial money-changers at the bazaars. The New York Times and the Financial Times reported that some seeking to buy U.S. dollars expressed a desire to escape coming inflation by not only securing foreign currency, but withdrawing their funds from the banks entirely and storing them at home.
When faced with particularly severe inflation which degrades standards of living and restricts access to basic provisions, Iranians, particularly in urban areas, have on several occasions, including in and since 1979 responded to poor economic conditions with large-scale contentious social action.
Some notable examples of inflation-linked demonstrations in Iran over the past 30 years include:
In 1990, strikes and demonstrations erupted across Iran, particularly among working-class urban residents whose quality of life was rapidly being eroded by inflation. At this time, the government’s development plan had yet to produce significant results while food and housing prices had skyrocketed over the preceding six years. Between 1984 and 1990, rents in Tehran’s working-class areas increased 134% while, across the country, required deposits went up 900%. Rising housing and food prices were responsible for numerous major demonstrations in Tehran and Esfahan in the summer of 1990. Moreover, in January and November of that year, massive strikes broke out at the National Shoe Factory and among public school teachers in Yazd, Shiraz and Esfahan as workers became fed up with stagnant wages as costs of living soared.
As inflation rebounded following the failure of the First Development Plan in 1993, more sporadic demonstrations broke out across Iran’s cities. These protests, particularly those in the city of Mashhad where demonstrators occupied police stations, led to the Islamic Revolutionary Guard Corps and the Law Enforcement Force of the Islamic Republic of Iran (NAJA) taking up more active roles in suppressing public protests.
Inflation arguably played a role in the massive demonstrations which broke out across Iran in June 2009. Incumbent President Mahmoud Ahmadinejad was declared the winner of that month’s presidential election by a nearly 30 percentage point margin over reformist candidate Mir Hossein Moussavi. As accusations of irregularities such as unusually fast tabulation and certification of election results and the barring of observers at polling stations, began to emerge, demonstrators took to the streets across Iran challenging the outcome of the election in what has been described as the “most significant threat to the regime’s grip on power to date.” Security forces reacted swiftly, killing between 25 and 100 protestors and arresting 2,500 between June 13 and June 19. Inflation lent credence, in the minds of many demonstrators, to charges that the 2009 election had been rigged. At the time of the election, Ahmadinejad’s policies had caused a 14-year record increase in inflation, with unemployment also on the rise. These economic factors, coupled with the unusually large size of Moussavi’s rallies in battleground districts suggested that Ahmadinejad’s landslide victory could not have been achieved legitimately. Other analyses however, suggest that Ahmadinejad still had strong support among the urban poor and rural residents, whose votes may have granted him a legitimate victory.
The wave of popular demonstrations that washed over Iran and captivated the world in the waning days of 2017 perhaps more clearly than any other post-1979 movement highlights the link between inflation and social unrest in Iran. In 2017, a disease outbreak among chickens caused the price of eggs to increase 50%. This price hike accompanied other spikes in the price of milk and meat, as well as stubbornly high unemployment and proposed tax increases.
Small demonstrations began in Mashhad, Iran’s second largest city, on December 28th and quickly spread across the country, popping up in no less than 100 cities. In all, it is estimated that between 40,000 to 50,000 people demonstrated between December 28th and the movement’s effective end on January 9, 2018. Though the demonstrations initially focused on the economic situation of the country, they quickly took a political turn. Many blamed the economic situation on the government, which demonstrators noted was spending heavily on military and financial aid to allies in Syria, Lebanon, Yemen and the Gaza Strip. Early chants of “Where’s my paycheck,” and “The people are begging,” were soon joined by “Leave Syria,” “[Supreme Leader] Ali [Khamenei] should be ashamed” and “Death to Rouhani.”
Though authorities initially dismissed the protests as the work of “counter-revolutionaries,” they soon cracked down. Clashes between protestors and security forces broke out in at least 42 cities and in total, it is estimated that 25 people were killed and between 700 and 5000 protestors were arrested over the course of the unrest.
How Does Tehran Plan to Combat Inflation in the Coming Years?
Re-imposition of sanctions means that Iran’s decades-long struggle with inflation is about to become exponentially more difficult, as economic growth, a strong currency and expansion of domestic productive capacity are essential to keeping inflation in check. Unfortunately, under the new sanctions regime, opportunities for this may be limited. Iran’s exports revenues have already fallen by nearly a third since June, and foreign investors—including many who had previously pledged to defy U.S sanctions such as the French oil giant Total, and China’s state-run oil company— have begun shying away from doing business with Iran.
Iranian leaders have responded to the re-imposition of U.S. sanctions by throwing ever-increasing support behind the so-called “resistance economy” philosophy. Under the ‘resistance economy’ model, proposed by Ayatollah Khamenei in 2012, Iran would insulate itself from the global economy through import-substitution industrialization, import bans, protectionist tariffs, greater emphasis on intra-national as opposed to international trade, reducing dependence on oil exports and keeping Iranian money out of multinational banks.
Though the idea of a “resistance economy” fell out of favor in the age of JCPOA, Iran has indicated that it will be moving towards this model as means of preserving its economy over the coming years. In June 2018, Tehran banned the import of 1,339 consumer goods including various home appliances, textiles, footwear and furniture which officials assert could be produced locally. In November 2018, semi-official Fars News Agency reported the ‘resistance economy’ philosophy is driving new interest in Iran’s carpet weaving industry. Officials intend to introduce low income people in disadvantaged parts of the country to carpet weaving and increase Iran’s exports of its distinctive carpets. So far this year, Iran’s exports of non-oil products such as carpets have already increased by nearly 20%.
Furthermore, Tehran has announced plans to revitalize six gold and copper mines across the country as a means of “increasing employment, creating added value for local communities, and ultimately achieving the goals of a resilient economy.” Domestic demand for precious stones in Iran has increased 200% since May 2018 and officials estimate that the country has some 340 metric tons of gold along with large deposits of zinc, copper and iron yet to be exploited.
It remains to be seen whether such ambitious initiatives will have any significant impact on the runaway inflation Iran is expected to face in the coming post-JCPOA era.