Abstract

Extended Abstract
 
Introduction and Objectives: Chronic inflation has persisted as one of the most enduring macroeconomic challenges in Iran over recent decades, consistently occupying a central focus for policymakers and analysts. The dominant economic literature in Iran, primarily grounded in conventional monetarist doctrine, attributes the root cause of inflation to rapid liquidity growth. This growth itself has traditionally been ascribed to the consequences of government budget deficits and public sector fiscal imbalances. According to this perspective, formulated within the theory of fiscal dominance, the Central Bank of Iran (CBI), under government fiscal pressure, is compelled to provide financing through the expansion of the monetary base, which is thus considered the principal driver of liquidity growth.
However, structural transformations within the country’s monetary and banking system in recent decades have cast doubt on the continued validity of this hypothesis. Employing an analytical-critical approach based on time-series data, this research evaluates the credibility of this hypothesis over four decades (1981–2021). The central research question is whether budget deficits and the mechanism of fiscal dominance remain the primary driver of liquidity growth in Iran, or if the banking system has emerged as the dominant actor in money creation. The ultimate objective of this study is to identify the disaggregated contributions of each factor (the government sector and the banking system) to the liquidity creation process and to provide a precise depiction of the internal logic of money creation in the Iranian economy.
Methodology: This study utilizes an analytical-computational method to analyze liquidity data in Iran’s economy from 1981 to 2021. The conceptual framework is based on the fundamental monetary identity (m × B=M), where M represents the liquidity volume, m the money multiplier, and B the monetary base. This decomposition allows for an independent evaluation of the roles of monetary policy and credit policy in the liquidity creation process.
The data were extracted from published statistics of the Central Bank of the Islamic Republic of Iran and from bank financial statements available on the CODAL system. The analytical procedure was conducted in five stages:

Decomposition of liquidity growth into its two components: the monetary base and the money multiplier.
Estimation of the contribution of each component to liquidity growth in each decade.
Decomposition of the monetary base into its constituent parts and calculation of their individual contributions to base money growth.
Integration of the results to ascertain the final contribution of each constituent part to overall liquidity growth.
Estimation of the banking system’s net contribution to liquidity growth through both the multiplier channel and banks’ debt to the central bank.

This process enables a more precise assessment of the internal logic of liquidity growth over the past four decades.
Findings:The results indicate a structural shift in the drivers of liquidity growth in the Iranian economy over the last four decades. In the 1980s, the fiscal dominance hypothesis is largely corroborated. The monetary base played the dominant role, accounting for 54% of liquidity growth. Among its components, net government debt to the central bank alone explained over 100% of the growth in the monetary base. This underscores the government’s dominant role in the money creation process during that period.
However, from the 1990s onward, the structure of liquidity growth transformed significantly. The findings demonstrate that the share of the money multiplier in liquidity growth gradually increased, becoming the dominant factor: rising from 46% in the 1980s to 61% in the 1990s, 75% in the 2000s, and finally reaching 84% in the 2010s. This trend signifies a transfer of the epicenter of money creation from the central bank to the banking network.
Based on the integrated results, the net contribution of the banking system (including both direct effects via the multiplier and indirect effects through its debt to the central bank) to liquidity growth increased from 50% in the 1980s to 69% in the 1990s, 82% in the 2000s, and finally 92% in the 2010s. These findings provide clear evidence that over the last three decades, the banking system has been the primary—and nearly exclusive—agent of liquidity creation in the country.
Discussion and Conclusions: The findings of this study challenge the traditional view prevalent in Iranian economic literature, which emphasizes the dominant role of government and budget deficits in liquidity growth. Empirical evidence shows that the money creation process over the past three decades has become increasingly endogenous and reliant on the behavior of the banking system, to the extent that one can speak of a conceptual transition from “fiscal dominance” to “banking dominance.”
This evolution carries significant implications for the effectiveness of monetary policy. Monetary policymaking within the traditional framework, focused on controlling the monetary base and enforcing government fiscal discipline, is no longer adequate. This is because the vast majority of liquidity (over 90% in the 2010s) is now generated through credit creation by banks, predominantly private ones. Furthermore, the increase in banks’ overdrafts from central bank resources, which has itself become a driver of monetary base growth, signifies the central bank’s passive role in response to the banking network’s behavior.
Consequently, achieving sustainable inflation control necessitates a redefinition of monetary policy approaches and a greater focus on precise regulation of the banking network. Key measures include enhancing effective supervision of bank balance sheets, revising statutory reserve ratios, implementing macroprudential policies, and strengthening the supervisory authority of the central bank. These steps are essential for curbing excessive liquidity creation, channeling liquidity toward productive activities, and achieving lasting stability in the country’s macroeconomy.
 
Acknowledgements: The author sincerely extends gratitude to the “Ghadr: Applied Economic-Social Research Center” for its scientific support and for providing the necessary platform and resources for this research. Undoubtedly, a portion of this study’s achievements is indebted to the accompaniment and support of this esteemed center.
Conflict of Interest: The author declares that there is no conflict of interest regarding the conduct of this research or the publication of its results