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This paper investigates the breakdown of a money-demand relationship derived from the Quantity Theory of Money for Iran during episodes of large fluctuations in the real value of oil exports. The joint rise in the inverse velocity of money and the real value of oil exports in the 1970s and 2000s suggests that conventional specifications fail to capture the oil-driven component of money demand. This issue is crucial for monetary policy, because the central bank must distinguish whether increases in desired real money balances stem from supply-side expansions in the transaction base or from shifts in money demand in order to calibrate an appropriate policy response. We hypothesise that real GDP is an inadequate proxy for the supply of goods and services in the Quantity Theory of Money framework, because swings in natural-resource rents from oil are largely excluded from real GDP growth even though, in practice, oil rents finance additional absorption and effective supply. To address this, we examine the impact of both the real price and the volume of oil on the inverse velocity of money using linear ARDL and nonlinear NARDL models. Using these models, we find a long-run level relationship between inverse velocity, the real oil price, and oil production, with positive long-run effects and a significant error-correction term. Asymmetry is concentrated in the short run for oil prices: positive shocks raise inverse velocity more than negative shocks reduce it. For oil production, increases lift inverse velocity while declines are muted, consistent with fiscal smoothing, monetization, and offsetting macroeconomic adjustments under sanctions. Policy should therefore be explicitly oil-contingent, separating oil-driven shifts in money demand from policy-induced balance-sheet expansion, and relying more on quantity instruments combined with fiscal and foreign-exchange sterilization during oil booms.

Keywords: Money demand, Oil price, Oil production, ARDL, NARDL, Fiscal dominance, Iran

     

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