Unveiling a Vicious Feedback Loop: A Smooth Transition VAR (STVAR) Analysis of Asymmetric Exchange Rate Pass-Through in Iran's Dual Economic Regimes

Document Type : Research Paper

Authors

1 Department of Economics, Mofid University, Qom, Iran.

2 Macroeconomics Research Group, Institute for Trade Studies and Research, Tehran, Iran.

Abstract

This study examines the nonlinear, regime-dependent relationship between exchange rates and inflation in Iran using a Smooth Transition Vector Autoregressive (STVAR) model with monthly data from 2000 to 2024. It rejects a linear model in favor of a two-regime analysis, identified as tranquil and crisis, with transitions driven by the level of the exchange rate. Key findings reveal that a one-standard-deviation shock to the parallel market exchange rate in the crisis regime causes an immediate 43% increase in consumer inflation, rising to 93% over two years, compared to a 30% increase in the tranquil regime. Additionally, the pass-through to the Producer Price Index (PPI) is stronger and faster than to the Consumer Price Index (CPI), indicating the vulnerability of the real sector. The exchange rate's contribution to inflation variance nearly doubles in the crisis regime. Robustness checks, including threshold VAR estimation and alternative lag structures, confirm the stability of these results. These findings emphasize that the Iranian economy is susceptible to a self-reinforcing feedback loop activated by crossing critical exchange rate thresholds. Without effective institutional reforms, the risk of a currency crisis remains, as external shocks or domestic policy errors could trigger a vicious cycle of inflation again. This situation underscores the need for a shift towards macroeconomic discipline and proactive management of expectations, as mere shock therapy tends to be counterproductive.

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References

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History

  • Receive Date: 30 November 2025
  • Revise Date: 04 January 2026
  • Accept Date: 05 January 2026

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