Contractionary Budget Comes With a Caveat: Higher Unemployment

Will the adoption of contractionary policies in the present economic conditions, now that the country is facing high inflation, sanctions and isolation, produce desirable results? This is an important question, the answer to which will determine the future of the country. 

Following the submission of the fiscal 2022-23 budget bill to Majlis [the Iranian Parliament], a wide swath of analytical commentary has been written on what propositions such a budget creates for the economy and the livelihood of people. Immediately after the bill was unveiled, it became clear that the government had tried to present a contractionary budget for the upcoming year, which choice will undoubtedly create certain conditions in the economy.

Basically, the country’s economic conditions are the result of previous choices. Countries regarded as developed or developing have chosen strategies that led to their development or underdevelopment. 

I have already said in several write-ups that (based on the Phillips curve in Iran) every choice has an opportunity cost in economics. From an academic point of view, the Phillips curve states that inflation and unemployment have an inverse relationship.

At least on paper, the contractionary 2022-23 budget suggests that reducing inflation is the government’s top priority. This choice may come at a high cost, i.e., an increase in unemployment, and if sanctions are not lifted, these consequences will be more critical. Therefore, the government must know what conditions await the economy by choosing this budget. 

In general, there are various theories in economics about the importance of choices. Based on these theories, it can be said that the current economic situation of the country is the product of choices that have been made over the past years. Thus, what we see in the economy of Iranian households today is the outcome of choices made by those in charge before, and what will be seen tomorrow will be the result of the decisions the incumbent government makes today.

All economies, including Iran’s, has a set of different curves from the short-term Phillips curve (with a negative slope); the curve moves to the right and up or vice versa left and down based on the inflationary expectations of the society. 

Fiscal 2013-14 onward, when inflationary expectations decreased thanks to the Joint Comprehensive Plan of Action, the Phillips curve shifted to the left and down, but since fiscal 2017-18, due to the growth of money supply and the withdrawal of the United States from JCPOA, inflationary expectations have increased sharply and the Phillips curve (short-term) has inclined to the right and up.  

Thanks to these developments, both inflation and (long-term) unemployment have risen from the bottom of the Phillips curve to a point at the top (and right) of the curve. This comes as Iran’s unemployment rate in recent years has exceeded the natural unemployment rate. Knowing that the slope of the Phillips curve and the extent to which expectations and other factors affect it in any economy can be a good gauge for policymakers. 

For example, governments have been pursuing anti-inflationary policies since the fiscal 2013-14; the intensity of these policies has led to an increase in unemployment. In other words, the intensity of these policies (contractionary or expansionary monetary policies in particular) may have a larger-than-expected impact on the economy and production. But if sufficient data are available for policymakers about the Phillips curve and other conditions, they may be less radical in the implementation of these policies to prevent the adverse consequences of inflation, or recession.

Now that the short-term Phillips curve is high, strong contractionary and anti-inflationary policies will have a greater impact on recession and unemployment. This, in turn, exacerbates poverty and reduces public welfare. Therefore, strict contractionary policies should be avoided. 

Iran’s economy suffered more from sanctions in the last decade than it did from the ramifications of the Iraqi war of 1980-88.

Iran’s economy has also been isolated from the global economy and has lagged behind in terms of development. Besides principled and internal policies, the economy cannot achieve economic development without reaching out to the world. Strategic changes must be defined and pursued; repetitive policies that have failed to produce desired results before will not work today. They will only inflict excessive damage on the society.