Suppressed Inflation and Exchange Rate Pass-through: Evidence from Iran

Based on empirical evidence backed by quantity theory of money, there is a proportionate reaction of the price level to an exogenous increase in the nominal money stock and it can cause a persistent inflation. However, governments control the relation between liquidity growth and inflation in the short run by managing exchange rate. Inflation control through government intervention using exchange rate in Iran, as an oil exporting country took place in last decades. Bearing sanctions in mind, exchange rate had significant overshoots causing two states in Iranian monetary environment. To capture the dynamics, this study using TAR estimation for liquidity, exchange rate and price levels over the period 2001-2025, detected exchange rate growth as the threshold variable at the value of 11% dividing economy into two states. In the low exchange rate regime, exchange rate changes have no statistically significant effect on inflation, while liquidity growth emerges as the primary driver and inflation persistence remains strong through significant lagged effects. In contrast, once the threshold is exceeded, exchange rate depreciation becomes a key and highly significant determinant of inflation, indicating intensified pass-through effects under higher volatility. Although liquidity continues to exert a positive and stronger influence, inflation persistence weakens, suggesting a shift from backward-looking dynamics toward contemporaneous shocks and potentially forward-looking expectations. Liquidity with a larger coefficient than in the lower regime, suggesting that monetary expansion has an even stronger inflationary impact under high exchange rate volatility which could not be suppressed.