Ma`rifat Eqtesadi

Chronic inflation is one of the key obstacles to economic development in Iran, and its analysis requires a multidimensional approach beyond conventional monetary explanations. This study is based on the Active Liquidity Theory, which emphasizes the functional distinction among components of liquidity, and tests this framework empirically against the traditional Total Liquidity approach. According to the active liquidity perspective, inflation results from the dynamic interaction of three core elements: the accumulation of inactive liquidity (as fuel), exchange rate shocks (as the spark), and the internal activation mechanism via currency substitution. To evaluate this hypothesis, two Vector Autoregression (VAR) models using quarterly data from 1991 to 2022 were estimated. The first model focuses on active liquidity (M1), while the second uses total liquidity (M-Total). Results from Impulse Response Functions (IRF) and Forecast Error Variance Decomposition (VDA) indicate that M1 shocks have a strong, immediate, and statistically significant effect on inflation, explaining over 31% of its long-term fluctuations. In contrast, M-Total explains only about 3%, with no statistical significance. Additionally, exchange rate shocks affect inflation primarily through M1, not M-Total. This transmission channel has structurally intensified since the 2018 currency crisis. The study emphasizes the need to shift policy focus from controlling total liquidity to managing its composition and addressing activation drivers, especially exchange rate instability.