Estimating DSGE Model with Zero Real Interest Rate Policy on Iran's Economy

Purpose: The Central Bank, as the organ in charge of monetary policies, implements those policies that achieve the selected final goals. In order to achieve these goals, central banks usually use a mechanism. In the first step, the operational tool is selected, and, in the second step, this tool has an effect on a variable called the intermediate goal. Then, through its changes, the final goals are achieved. Depending on the economic conditions and environmental characteristics, the selected tools of the central bank can have different degrees of effectiveness in achieving the macroeconomic goals. Since the monetary policy used in Iran's economy is based on the prohibition of usury and the non-use of interest rates, the question to arise is how the restriction of zero interest rate (prohibition of usury) is applied in the Islamic economic system. Although we know that the theory of zero interest rate, which is discussed in conventional economics, has structural (theoretical and practical) differences with the concept of prohibition of usury, it can  have implications for the Islamic economy and our country. In this regard, the issue of compensation for currency depreciation has always been the focus of Islamic economic researchers. For example, compensation for the depreciation of money up to the inflation is accepted according to the fatwa of the Supreme Leader of Islamic Republic of Iran. Therefore, it is necessary to evaluate the economic effects of the zero real interest rate policy on the variables of Iran’s macroeconomics and analyze its consequences. In this regard, the purpose of this study is to investigate the effects of zero real interest rate monetary policy on macroeconomic variables.
Methodology: In this research, a Dynamic Stochastic General Equilibrium (DSGE) including the banking system has been designed, in which the central bank determines the policy interest rate in the market by using the open market operation tools and implements its monetary policy. In the conventional structure of DSGE models, it is necessary to determine the parts of the model at first. In this study, the described parts are household, banking system, producer of final goods and services, government and the central bank as the determiner of interest rates. The study also uses the seasonal data of the period 2009-2021 with the Bayesian method.
Findings and discussion: The findings of this research show that, based on the defined monetary policy rule, the interest rate reacts to changes in the inflation rate and production. According to the findings, the reaction of macroeconomic variables to the shock of one percentage increase in the nominal interest rate is as expected. With the increase in the interest rate, household consumption decreases. Based on the optimal path of the investment expenses, the investment costs and, consequently, the amount of the capital decrease. As the marginal cost items decrease, the total production level decreases too. Therefore, based on zero real interest rate, the direction and path of change of important macroeconomic variables in the policy is in line with expectations. The effects of the zero real interest rate policy show themselves better when compared to those of the non-zero real interest rate policy. The rule based on zero real interest rate is less able to control economic fluctuations because, in the case where the monetary policy maker actively reacts to economic fluctuations (non-zero real interest rate policy), its response to the inflation rate is not point-for-point. So, it can control economic fluctuations by changing the real interest rate.
In the case where the interest rate reacts exactly point-for-point to the inflation rate, because the real interest rate does not change, there is no noticeable change in the path of macroeconomic variables; therefore, in the face of economic shocks, stable equilibrium will not be established. In fact, the zero real interest rate, meaning the equality of the nominal interest rate and the inflation rate, violates Taylor's principle in monetary policy. According to Taylor's principle, the policy based on the interest rate rule can lead to a sufficient response to the variables, thus reestablishing the balance if the sensitivity of the interest rate to the inflation rate is greater than point-for-point. If this sensitivity is equal to one, it cannot bring the stable equilibrium conditions for the economy.
Conclusions and policy implications: As it was said, in the current situation of the country, the implemented interest rate indicates the passive state of the monetary policy. In other words, it shows that it cannot bring a stable balance in response to economic shocks. In the current research, it has been tried to simulate the effects of implementing the policy of zero real interest rate and analyze its effects on macroeconomic variables, considering the theories about compensation for currency depreciation and the recent fatwa of the Supreme Leader of Islamic Republic of Iran, as well as some theories based on the zero real interest rate in the conventional economy. The results of this simulation show that the mentioned policy cannot guarantee the establishment of equilibrium in the economy after the occurrence of a shock. This is because, like the current monetary policy of the central bank, this policy violates Taylor's principle. Therefore, in line with the mentioned fatwa on compensating the depreciation of the currency up to the inflation rate and in order to correct this policy rule, some variables can be considered to achieve a stable balance. These variables are such as the population growth rate, economic uncertainties, political subsidies, etc., which can be the subject of future research.