A Projection of inflationary gap on the basis of P* model in Iran

Different economic schools have for long been discussing the
relationship between money and price introducing different definitions
of inflation on the basis of their particular views. However, it can be said
that most of the economists unanimously believe that inflation in the
long run is a monetary phenomenon.
Iran has experienced different rates of inflation in the period between
A.D. ١٩٦١-١٩٩٨ A.H. (solar) ١٣٤٠-١٣٧٧. Several extensive studies were
made in Iran to analyze this issue, most of which concentrated on
monetary approach.
In this paper we, too follow the monetary approach in our discussion of
the subject relying on the recently introduced P
* Model Method.
Velocity and output gaps and the occurrence of financial innovations
and major developments in money circulation (velocity) were used in
making this study.
First we try to apply the performance of the standard P
* model in Iran.
Then the extended P
* model, in which both domestic and foreign price
gaps are considered, will be examined.
The Results of the study show that the domestic price gap cannot
explain the inflation in Iran. The reason is that because velocity is
unstable, it depends on volatility of exchange rate. Also, the output gap
does not play a significant role in various versions of their inflation
models. On the other hand, aggregate price gap and foreign price gap
explain our inflation clearly and it can be said that foreign price gap has
a crucial role in defining inflation.