The monetary policy compatible with Iran's oil economy with the BVAR-DSGE approach

Considerable reserves of oil endowment coupled with oil's lion share of export revenues have brought in high economic dependence on oil revenues giving rise to oil dominant role in public budgeting and policy making and thus higher level of vulnerability to global oil shocks. Therefore, designing monetary policies that are consistent with Iran's economic structure and help secure macroeconomic stability is of utmost importance.
This article seeks to examine 2 cases of Central Bank reaction function within a Dynamic Stochastic General Equilibrium model customized to the intrinsic characteristics of Iran economy. In case one, policymaking is based on level of output, deviation of actual inflation from target as well as exchange rate where in case two, policymaking is based on output gap, deviation of future inflation from target And exchange rate while both cases allow for use of policy experiences. Moreover, in order to minimize prediction error of DSGE model and to ensure theory-data alignment, we have estimated the model by means of BVAR-DSGE hybrid method. After estimating the model using Bayesian approach, we examined the dynamic impact of oil, monetary and exchange rate shocks on macroeconomic variables over the period 1369:1-1392:4. In response to oil and exchange rate shocks, production and inflation drop while the variables rise in response to monetary shocks. Furthermore, positive oil and exchange rate shocks generate an increase in construction spending. Another important finding is that government is encouraged to make policy decisions with more emphasis on prior experiences in order to minimize output gap and to control future inflation