MEASURING THE IMPACT OF FISCAL DOMINANCE ON THE EXCHANGE RATE GAP IN IRAQ USING THE ARDL MODEL

Abstract

This paper analyses and measures the effect of fiscal dominance on the growth of the exchange rate gap in Iraq during (2015Q1-2025Q4). The study uses the Autoregressive Distributed Lag (ARDL) bounds testing model and the Error Correction Model (ECM) using a one-dollar dummy variable to represent the structural shock caused by the introduction of the Electronic Compliance Platform in 2023 using quarterly data. Independent variables that act as proxies of fiscal dominance were the fiscal balance to GDP ratio, and the ratio of discounted transfers in relation to domestic debt, whereas the dependent variable is the exchange rate gap. Empirical evidence indicates that there is a long-run cointegration, which exists between the variables. Precisely, discounted transfers have a remarkably positive effect on the enlargement of the exchange rate gap to validate that debt monetization to fund the deficit is the major path through which fiscal dominance influences the parallel market. Additionally, the dummy variable demonstrates that the gap had increased considerably due to the tightening of international compliance restrictions. The value of the error correction coefficient (-0.71) shows a fast rate of adjustment to the equilibrium. The paper finds that the mitigation of fiscal dominance necessitates the shift to non-inflationary financing tools, the use of financial monitored coordination systems to match the supply and demand and to minimize the negative impact of fiscal pressures on the independence of the monetary policy.