Stabilization policies in a behavioral macroeconomics model

Document Type : Research Paper

Author

Faculty of Economics, University of Tehran, Tehran, Iran.

Abstract

The relationship between inflation and output (or unemployment) has been and remains a controversial topic. A turning point in this debate is the Friedman-Phelps hypothesis, which asserts that there is no long-term relationship between the two. This idea is accepted by many economists, though doubts about it persist. On the other hand, the trade-off between the volatility of inflation and output has also drawn attention. Within the framework of DSGE models, stabilizing output leads to greater inflation volatility, and similarly, stabilizing inflation results in greater output volatility. In other words, there is a trade-off between stabilizing output and inflation. The findings of this paper suggest that, in addition to a negative relationship, a positive relationship between the volatility of inflation and output may also exist. The results indicate that in a behavioral macroeconomic model, it is possible for a positive relationship between inflation and output volatility to emerge. Such findings also hold for Iranian economic data, demonstrating that the relationship between inflation and output volatility is fully consistent with the outcomes of the behavioral macroeconomic model. These results are valid for both annual and quarterly data. The most important implication of these findings for policymaking is that it is possible to reduce both inflation and output volatility simultaneously. We also show that such simultaneous reductions have occurred during periods when real bank interest rates were positive or close to zero. In this context, the impact of monetary variables and the exchange rate is also examined.

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References

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Journal of Economic Research (Tahghighat- E- Eghtesadi)
Volume 60, Issue 1
June 2025
Pages 858-886

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History

  • Receive Date: 16 June 2024
  • Revise Date: 20 February 2025
  • Accept Date: 10 May 2025

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