Monetary Policy Rule in Case of Inflation Persistency of Iran: An Optimal Control Approach

This research follows two aims in case of the Iranian economy. First, study of the presence of inflation persistency, and second, looking for an optimal monetary policy rule. Results show that inflation in the economy of Iran is persistent, in which, short-term and long-term effects of monetary policy should be considered. For this purpose, a loss function for the central bank with arguments of inflation, output gap and the money supply growth, subject to the demand and Phillips curves, is minimized. The importance of this issue is that by expansionary monetary policy, the economic growth in the short-term can be increased with high inflation bias. On the other hand, by contraction monetary policy, benefits gained in the form of inflation reduction at the cost of lower short-term growth. Therefore, balancing among costs and benefits of inflation targeting policy with regard to the output stability is crucial, as it is optimal for the central bank to allow for a high degree of policy gradualism or money supply smoothing.