Optimal Monetary Policy and Inflation Targeting

Document Type : Research Paper


1 University of Tehran

2 University of Shiraz, Faculty of Economics


In this paper, by using dynamic stochastic general equilibrium, optimal monetary rule derived for central bank of Iran. Monetary transmission mechanism of the model includes four equations, aggregate demand, aggregate supply, oil price and Taylor rule. We have proved that dynamic structure of aggregate demand relation, regarding monetary inflation in Iran, is a function of money growth rate. With this assumption that the goal of central bank is to pursue target inflation rate and output gap, and subject to monetary transmission mechanism, optimal rule of monetary policy obtained for Iran economy that is a function of inflation gap, output gap and oil income growth rate. Estimation results show that money growth rate has no effect on output gap and fully reflexes in inflation expectation. Moreover, one percent increase in oil income causes four percent increase in inflation rate.
JEL Classification: E31, E42, E51, E52, E58