Optimal Cyclical Behavior of Monetary Policy of Iran: Using a DSGE Model

Abstract

The countercyclical monetary policy is a policy that economists recommend to adopt in order to slow down the economic fluctuations. The aim of this study is to address the question that, in the presence of fiscal dominance and considering institutional quality (IQL), what the optimal monetary policy should be during the business cycles? To find the appropriate answer, first, in the framework of a Dynamic Stochastic General Equilibrium (DSGE) model, proportional to the structure of the Iranian economy, the parameters of the model are derived. Then, considering fiscal dominance and institutional quality, the optimal monetary policy during the business cycles is calculated and by using the equilibrium parameters, using data of Iran during 1991:2-2016:1, it is calibrated. The results show that the optimal monetary policy during business cycles of Iran is a countercyclical monetary policy. The optimal monetary policy coefficient during the business cycles decreases by a decline in institutional quality and an increase in fiscal dominance. In addition, when the policymaker's goal is only stabilizing inflation, the optimal monetary policy is independent of the business cycles. In addition, when the monetary policy is assumed completely independent, the optimal policy coefficient takes the highest value compared to the other assumed conditions.