comparing the effect of monetary and financial policy in the currency regimes of Iran's economy on growth and inflation with the stochastic dynamic general equilibrium approach

Document Type : Research Paper

Authors

1 PhD student in Faculty of Economics and Political Sciences, Shahid Beheshti University, Tehran, Iran

2 Assistant Professor, Department of Economic Sciences, Faculty of Economics and Political Sciences, Shahid Beheshti University, Tehran, Iran

3 Assistant Professor Faculty of Economics and Political Sciences, Shahid Beheshti University, Tehran, Iran

4 PhD in Economics, Planning and Budget Organization, , Tehran, Iran

Abstract

Purpose: Macroeconomics policies places great importance on sustainable economic growth and price stability, and achieving these goals relies heavily on effective financial and monetary policies. Researchers have conducted experimental studies to determine the most suitable combination of these policies to influence key economic variables, particularly growth and inflation. The impact of monetary and financial policies on production and inflation is influenced by various factors, including currency regimes.
Several studies have explored the relationship between financial and monetary policies and economic growth while considering the currency regime. Gali (2007 and 2015), Navid Jameel et al. (2023), and Biabani et al. (2021) are noteworthy examples of such studies. Furthermore, the effects of monetary and financial policies on inflation can vary significantly depending on the currency regime and other factors. Walugo et al. (2023) examined this issue in Ghana, analyzing the inflation targeting framework of the country's monetary policies. The results indicated that the effectiveness of monetary and financial policies was greatly influenced by the currency regime and exchange rate in Ghana.
Despite numerous foreign studies on the effectiveness of monetary and financial policies in different currency regimes, empirical studies in Iran's economy have not investigated or compared the effects of these policies under different currency regimes. This article aims to fill that gap by examining the impact of monetary and fiscal policies within the context of the currency regimes experienced in Iran's economy. Iran's economy is characterized as a small, open economy heavily reliant on oil revenues. The analysis will be conducted using a Dynamic Stochastic General Equilibrium (DSGE) framework.
Metodology: This article employs a Stochastic dynamic general equilibrium model within the framework of a small open economy to analyze the impact of economic sanctions on the Iranian economy. The analysis is based on the principles of New Keynesian economics and assumes the presence of price and wage stickiness. The study focuses on the decision-making process of the household sector, which optimizes choices related to consumption, labor supply, and money demand. Additionally, separate specifications are made for the new Phillips Kinesin curve, capturing both domestic and imported inflation.
Given the dominant role of the financial sector and the limited independence of the central bank, the study combines the government budget with the central bank's balance sheet. The monetary and currency policy is modeled through two channels: foreign assets and the volume of liquidity. In Iran, where interest rates are controlled, the study replaces the interest rate targeting policy with the growth rate of liquidity as a key instrument of monetary policy. The model incorporates two policy instruments: intervention in the currency market and adjustments to the money growth rate.
The study divides the currency regimes experienced in Iran into three periods. The first period covers the years 1368-1380, characterized by a multiple exchange rate regime. Although multiple authorized and official rates were present during this period, it resembles a fixed regime to some extent. The second period spans the years 1381-1390, during which a floating currency regime was implemented. The third period encompasses the years 1391-1401 and resembles the first period in terms of a multi-rate regime. However, compared to the first period, this regime exhibits greater exchange rate fluctuations and a reduced variety of rates, making it more flexible.
Findings and Discussion: he interpretation of the instantaneous reaction graphs reveals several key findings. Firstly, expansionary fiscal policy has a positive effect on production in multi-rate regimes, but a negative effect in managed floating regimes. Moreover, the positive impact of government expenditure shocks on inflation is greater in the multi-rate regime of the first period compared to the third period. This finding aligns with Mandel-Fleming's studies, which suggest that financial policies are more effective under a fixed currency regime. In such a regime, to prevent the strengthening of the national currency, monetary policy needs to be expanded, thereby reinforcing the initial effects of fiscal expansion on spending.
Regarding monetary policy, the results indicate a positive effect on production in the fixed currency regime, but a negative effect in the second and third periods when the currency regime is managed floating or multi-rate (close to floating). These outcomes suggest that the increase in liquidity in recent years has been predominantly absorbed by non-productive activities, resulting in a lack of real impact of monetary policy on production growth. Interestingly, monetary policy has led to increased inflation in all three periods.
Additionally, the study findings demonstrate that the managed floating currency regime incurs the least welfare loss in response to monetary and financial policy shocks.
Conclusions and Policy Implications: Based on the study's findings, it is evident that the managed floating currency regime results in the least welfare losses when facing monetary and financial policy shocks. Iran has identified itself as a country adopting a managed floating exchange rate regime within its development program. However, the implementation of this currency regime has only been possible for a limited period. Therefore, it is recommended that the prerequisites for an effective performance of this currency regime be considered, including inflation targeting, independence of the central bank, and adherence to an appropriate range of exchange rate fluctuations. These measures align with the legal requirements of the monetary authority in implementing a managed floating currency regime.

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References

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The Journal of Economic Policy
Volume 18, Issue 35
April 2026
Pages 1-40

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