According to the latest Economic Trends Report published by the Central Bank of Iran (CBI) in September 2026, the Iranian economy experienced an inflation rate of 48.3%, unemployment rate of 7.6% and a fairly unchanged aggregate demand in the fourth quarter of last year. The CBI has also kept the policy rate at 23% while the non-oil real GDP growth has declined to -1.1%. Assuming that the primary objective of the CBI is to achieve price stability, using an IS-PC-MR framework, the CBI should commit to gradual rises in the real policy rate subject to government’s support in fiscal policy.
With the current real policy rate at -25.3%, and considering that the Iranian economy’s IS curve is not particularly inelastic, the CBI’s ability to increase the real policy rate is very limited. This is because any rise in the rate could cause a large reduction in the aggregate demand. It is reasonable to assume that our IS curve is primarily elastic due to Iran’s historically low rates of taxation and a low marginal propensity to consume. Therefore, raising the real policy rate per se cannot be a viable long-term strategy. Instead, by gradually altering the slope of the IS curve and shifting it up while increasing the real policy rate incrementally and accepting temporary negative output gaps, we could achieve a new stabilised equilibrium. This way the real policy rate can become positive while the CBI would be capable of managing inflation expectations.
To begin this process, first, the government should pursue a contractionary fiscal policy by raising the income tax rate. The income tax rate is a component of the slope of the IS curve and the higher it is the larger the fraction and the steeper the slope. This slope change helps the CBI to raise the real policy rate while minimising the consequent fall in output. Once tax rate rises, considering we have the same -25.3% policy rate, aggregate output falls. With a fall in the output, fewer jobs will be needed and therefore employment declines, the collective bargaining power diminishes and thus workers will be happy to accept lower wages. Price setters then will lower the prices of their products and as a result inflation decreases as the economy moves down its Phillips curve. Additionally, this might reduce the expected inflation and allow a downward shift of the Phillips curve in the next period.
Second, the government should raise government spending in order to shift the IS curve higher. Doing so would increase the aggregate output produced at every policy rate, therefore to avoid raising inflation expectations, the CBI must simultaneously undertake a policy rate hike. The policy mix of government spending increases and real interest rate hikes allows the CBI to keep raising the policy rate while due to the repetitive positive shifts of the IS curve, the previous level of output can be maintained. It is however more desirable to continuously allow for small GDP reductions so that there are movements along the Phillips curve which can alter expectations and lead to more downward shifts of the Phillips curve.
Third and finally, after achieving a sufficiently positive real interest rate, the now-very-high nominal interest rate must fall to rekindle private investment. The new inflation rate is low as expected inflation has fallen significantly and a new Phillips curve has been derived. Hence reducing the nominal interest rate does not require forgoing price stability and the CBI can start cutting the policy rate along its newly-determined standard Monetary Rule (MR) curve to prioritise GDP growth. The economy then can achieve a medium-run equilibrium, ceteris paribus.
The attempts to raise the repo cut-off rate from 19% to 23% in 2022-23 were some good steps, however they should be continuous and accompanied by appropriate fiscal policy.
