Exploring the Effects of Monetary and Fiscal Policies on Value Added of Service Sector in Iran’s Economy

اقتصاد پولی مالی

Article 1, Volume 23, Issue 12, February 2017, Pages 1-18   

Document Type: پژوهشی

DOI: 10.22067/pm.v23i12.40011

Authors

Mohammadali Motafakker Azad¹; Seyyed Jamaladdin Mohseni Zonozi²; Omid Mohammadgholi Pour Tappeh^{* 3}

¹Tabrize University

²Urmia University

³Tabriz University

Abstract

For many years, developing countries were neglecting the importance of service sector because of this viewpoint that only investment in industrial infrastructures can accelerate development. During the recent centuries, investigating share of services in the GDP of developed countries and comparing it with its relevant quantities in the GDP of developing countries, showed that progress and development has a direct relationship with growth of service sector (Singh, 2006).
In spite of the notable importance of service sector in international economy, our country could not yet match itself with changes of this sector to use its advantages. It seems that dominant thought among decision-makers and the public about service sector is equivalent with speculation that damages production (Ministry of Economic and Assets Affairs, 2010). Although the importance of service sector is confirmed, no studies have been done for recognizing the effects of economic policies on growth of this sector. Monetary and fiscal policies are among economic policies that are widely used for achieving economic growth. There are different views about effectiveness of monetary and fiscal policies in the economic literature, so before recommending them, we should investigate theirs effect.

Theoretical Framework
Governments persistently make efforts to attain their goals such as increasing employment, growth, development and welfare, or decreasing inflation and poverty, through economic policies and instruments (Hashemi Dizaj, 2007). Economic policies are usually divided to two categories: the first type is known as "Direct Policies". Direct or demand management policies are generally monetary and fiscal policies. The second type is "Indirect Policies", they are generally trade and income policies (Ragoobur, 2010).
Taxes, government expenditures, and transfer payments are instruments of a fiscal policy. Monetary policy’s instruments are: reserve requirement ratio, rediscount rate, open market operation, and qualitative instruments (Hashemi Dizaji, 2007).
Changes in policy instruments affect the production of various sectors including service sector, so it leads to growth of service sector’s production. To illustrate the mechanism through which monetary and fiscal policies affect the production, we consider an example of expansionary fiscal policy.
By applying an expansionary fiscal policy, the demand for goods and services will increase. This causes moving of IS and AD curve to the right. At previous prices, the economic system will face excess demand that pushes prices to enhance. Enhancement of prices has three effects:
1) Wealth effect: because of the increase of prices, real wealth of consumers declines. Therefore, consumption of the public decreases, too. So IS curve turns to a little to the left.
2) Real money balances: higher prices decrease real money balances (MS/P) so LM curve moves to the left.
3) In the labor market, the demand of firms for labor force increases due to price enhancement of their products. On the other hand, supply of labor decreases. Because we assume incomplete money illusion, finally employment will rise. It is clear that, in the final equilibrium all variables increase including production.

Methodology
In this study, the effects of monetary and fiscal policies on production of service sectors were investigated by ARDL model. For examining the existence of long run relationship between variables of the study, bounds test procedure introduced by Pesaran et. al. (2001) was used. In this procedure, they obtained two critical values. One of them through the assumption that all variables are stationary or in other words, are I(0), and the other one, by considering that all variables are stationary By differencing the first order or let's say, are I(1). We estimate an Unrestricted Error Correction Model (UECM) presented in equation (1).


Where: SE is value added of service sector; GR is government expenditures; M2R is liquidity. We compute a critical value by examining this hypothesis: C4=C5=C6= 0. Then it will be compared with the critical value of Pesaran et al. When the critical value (absolute quantity) is more than that of Pesaran et. al., we conclude that there is a long run relationship between variables; otherwise, the existence of long run relationship will be rejected. We estimate through the following ARDL model:

Results and Discussions:
After checking stationary of the variables and existence of long run relationship, short and long run and short run dynamics (ECM ) were estimated. Estimated Results show that, there is a long run relationship between the variables of the study. The effect of monetary and fiscal policies on production of service sector is significant in both short and long run. Comparison of short run and long run coefficients reveals that, coefficient of monetary policy is more than coefficient of fiscal policy in long and short run. Furthermore, results of ECM indicate that any deviation from long run equilibrium is adjusted in 0.75 of one period.

Conclusions and Suggestions
The results of this research show that monetary and fiscal policies have significant effects on the production of service sector in both short and long run. Therefore, we can use these policies for achieving growth of this sector. Furthermore, in this regard, monetary policy could play a more important role because it is more effective than fiscal policy. Since coefficients of both monetary and fiscal policy in the long run are more than their relevant quantities in the short run, policy makers should be patient when they implement these policies. Because these policies need time for revealing their full effects.

Keywords

monetary and fiscal policies; value Added of Service Sector; Auto Regressive Distributed Lags Model; Bounds Test Procedure

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