International Journal of Business and Social Science Vol. 2 No. 15; August 2011 258 Inflation in the Islamic Republic of Iran: Apply Univariate and Multivariate Cointegration Analyses Hamed Armesh Multimedia University Malaysia E-mail: Hamed_DBA@yahoo.com Abbas Alavi Rad Islamic Azad University-Abarkouh Branch Iran E-mail: Alavi_rad@yahoo.com Ramin Azadavar Islamic Azad University of Tehran (Iran) Saeid Zarezadeh Multimedia University E-mail: zarezadeh.s@gmail.com Mojtaba Saeidinia MBA,MSU E-mail: moji_island@yahoo.com ABSTRACT This paper examines the factors that explain and help forecast inflation in Iran. A simple inflation model is specified that includes liquidity (M2), real GDP and import prices, as well as the wheat support price as a monetarist approach. We have used multivariate and univariate cointegration analyses and error correction model (ECM) to determine the effect of liquidity (M2) and other variables on inflation in long run and short run. Quantitative estimates based on the time series annual data from 1961 to 2007, indicate that liquidity (M2) as well as real GDP and import prices have a significant effect on inflation in long run. It is also important that the long run estimated coefficients in ARDL approach the point of view of size element with the Johansen and Juselius (1990) maximum likelihood cointegration approach is symmetrical. The results of ECM show that estimated coefficients of model in short run are less than estimated coefficients in long run. The coefficient of the error correction term (ECT) is equal to -0.31. According to this estimation, speed of adjustment is slow. In addition, the ECM only can explain 85 per cent of fluctuation of prices. JEL Classifications: E31; C22; C32 Keywords: Inflation; Cointegration; Error Correction Model (ECM); Iran 1. INTRODUCTION Inflation in an open economy can be influenced by both internal and external factors. Internal factors include, among others, the government budget deficit, monetary policy and structural regime changes (revolution, political regime changes, etc.). External factors include terms of trade and foreign interest rate, as well as, the attitude of the rest of the world (sanctions, risk generating activities, wars, etc.) toward the country. The Iranian economy has suffered from high inflation since the advent of the revolution in 1979. Inflation in Iran has historically been moderately high, and the main source of inflation in the long run has been the financing of large government deficit by monetary expansion (Komijani, 2006). Central bank of Iran has not chosen freely instruments for monetary policy. Iran has experienced the financing of government budget deficit through central bank between 1980 and 2002. Thus, we have observed huge government budget deficit, high growth of liquidity and double-digit inflation rates in the last three decades. Over the period 1989-2002, net debt to government and the total private sector liquidity (namely the M 2 measure of money supply) grew by average annual rates of 22.1 and 26.6 per cent, respectively. On the other hand, the average annual growth of GDP during this period was 4.9 per cent, which was lower than average annual rates of M 2 . So, high growth of liquidity can explain some part of inflationary process in Iran. The purpose of this paper is twofold. First, it employs the monetarist model of inflation, augmented with the Import prices to identify the determinant of inflation in Iran using the data over the period 1961 2007 in long run and short run. Second, it compares results of multivariate and univariate cointegration tests on selected model of inflation in Iran.