This study investigates the impact of financialization on economic instability in Iran over the period 1991–2024. Financialization, characterized by the expanding role of financial markets and institutions relative to productive activity, has been linked to macroeconomic volatility and financial instability in both developed and developing economies. The analysis employs an Autoregressive Distributed Lag (ARDL) model to examine the relationship between the annual growth of the financial sector’s value added relative to GDP and inflation volatility, used as a proxy for economic instability, alongside exchange rate fluctuations and government reliance on central bank financing as control variables. The results demonstrate a significant long-run positive relationship, with a 1% increase in financial sector growth associated with an approximately 0.14 percentage point rise in inflation volatility. The findings also reveal the substantial contribution of external shocks, particularly exchange rate pressures stemming from international sanctions, and fiscal dominance, which together compound the destabilizing effects of financialization. Diagnostic tests confirm the robustness of the model, indicating that financialization has been a major contributor to Iran’s long-term macroeconomic instability, alongside external constraints. By focusing on Iran, this study contributes to the limited but growing body of literature on financialization in developing economies and highlights the need for regulatory reforms that mitigate the destabilizing effects of financialization, strengthen fiscal discipline, and redirect resources toward productive investment.