Optimal and Discretionary Monetary and Exchange Policies in Iran: A DSGE Approach

Macroeconomic equilibrium depends on both current and future behaviour of the monetary authority. Policymaker can manage economic agent's expectation by determining a specific rule in monetary policy and commit to it. There is a vast literature on central banks incentive in instrument and target choice in monetary economics. According to this literature, this paper studies discretionary and Ramsey optimal monetary policies for Iran in a small open economy dynamic stochastic general equilibrium model which is modified to capture the properties of the economy of Iran. The empirical results show that if there is a commitment to targets, monetary authority can control inflation. However, if the authority implements discretionary monetary policy, despite having two policy instruments of monetary base growth rate and nominal exchange rate depreciation, central bank could not manage expectations and would face inflation bias and higher volatilities.