Exchange Rate Fluctuations and Output in Oil-Producing Countries: The Case of Iran

Conventional wisdom states that currency depreciation in oil-producing countries is contractionary because demand effects, limited by the prevalence of oil exports priced in dollars, are more than offset by adverse supply effects. Iran, however, has experienced a rapid increase in nonoil exports in the past decade. Against this background, the paper tests whether the conventional wisdom still applies to Iran and concludes that the emergence of the nonoil export sector has made currency depreciation expansionary. The expansionary effect is particularly evident regarding anticipated persistent depreciation in the long run. Notwithstanding the varying effects of exchange rate fluctuations on the demand and supply sides of the economy, managing a flexible exchange rate gradually over time toward achieving stability in the real effective exchange rate may strike the necessary balance.