This paper examines the impact of macroeconomic policies in the era of sanctions on the Iranian economy. The results illustrate the role of the money supply and government spending in supporting growth, but contributing to inflationary pressures in the long-run, attesting to supplyside constraints. In the short-run, policies have aimed to provide support to the economy in the face of continued fluctuations with the oil price and spillovers from the geopolitical tensions attributed to sanctions. The exchange rate has played a key role in absorbing, but at times magnifying the adverse effects of these tensions. Continued deterioration of the fundamentals of the Iranian economy forced an official devaluation as the exchange rate proved to be misaligned with the fundamentals of the economy against the backdrop of the limited capacity of the Central Bank to continue to intervene to defend it. In the meantime, a parallel exchange rate market has been flourishing to satisfy the market’s needs for foreign exchange as culminated in the spread between the market exchange rate and the official exchange rate. A wider spread between the parallel market rate and the official rate has signified overvaluation of the rial and proved to be a major source of inflationary expectations and pressures. Wider spread has demanded frequent interventions by the Central Bank to defend the official rate and ultimately has forced an official devaluation of the exchange rate, further increasing inflationary pressures with negative effects on the output supply given high dependency on imports for consumption and investment. As the Iranian economy continues to be challenged by the effects of the unfolding sanctions, policy priorities should be focused on easing structural bottlenecks and enhancing domestic production capacity to reduce the adverse effects of the exchange rate devaluation on output supply and inflationary pressures.
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