The Iranian currency (rial) depreciated on average 12.2 per cent per annum against the U.S dollar during the period 1960-1998 but, despite continued two-digit rates of inflation, the rial has witnessed only a meagre 1.7 per cent fall in its value in the post 1998 era. This paper examines this perplexing issue by identifying the major long-run determinants of the black market exchange rate. This paper uses the multivariate cointegration test, a threshold regression model and annual time series data (1960-2008) to determine exactly at what exchange rate the effect of relative prices on the exchange rate has been subject to an asymmetry adjustment process. We found that the relative CPIs in Iran and the U.S., total stock of foreign debt and the price of crude oil are the major long-run determinants of the black market exchange rate. However, the impact of relative prices (as measured by the magnitude of its elasticity) has significantly diminished from almost unity in the pre 1998 period to less than one-fourth since 1998. Based on our results, if oil prices continue to plunge, liquidity and inflation are out of control and at the same time Iran accumulates more external debt, the exchange rate will eventually exhibit an unprecedented and explosive depreciation in the coming years. No previous study has examined this issue using a threshold regression model without splitting the entire sample into two sections according to an endogenously determined threshold for the exchange rate.
Available at: http://works.bepress.com/abbas/42/