Stock Market Bubbles and Business Cycles: A DSGE Model for the Iranian Economy

Abstract

T

his paper investigates the movement between stock market bubbles and fluctuations in aggregate variables within a DSGE model for the Iranian economy. We apply a new Keynesian monetary framework with nominal rigidity in wages and prices based on the study by Ikeda (2013), which is developed with appropriate framework for the Iranian economy. We consider central bank behavior different from Taylor Rule, and we suppose an economy with oil export. In order to study the role of money in economy, we apply “Money in Utility" approach. We study the TFP shock, the monetary policy shock, the government spending shock, the oil income shock and the sentiment shock. Bubbles in our model emerge through a positive feedback loop mechanism supported by self-fulfilling beliefs. Moreover, a sentiment shock drives the movements of bubbles that explain most of the stock market fluctuations and variations in real economy. The result of calibrated model reveals a relation between moments of variables in the model and moments of real data in the economy. Therefore, this model can help us to analyze the effect of stock market bubbles on macroeconomic variables in the economy.