Analyzing Central Bank Responses to Exchange Rate Volatility in Iran

Document Type : Research Paper


1 Faculty of Economics, University of Shiraz, Iran

2 Associated Professor, Faculty of Economics, University of Tehran, Tehran, Iran


In this paper, based on a new Keynesian structure, we have analyzed monetary policy response to exchange rate volatilities in Iran. For this purpose, first, exchange rate derived from equilibrium condition in exchange market and then two different models have been estimated. Assumption on the first model is that central bank responses to exchange rate volatilities and the assumption on the second model is that central bank does not response. To opt proper model, Bayes factor and Likelihood ratio tests have been used. The results show that, first model is a better model in describing central bank’s behaviour. In other words, central bank has responded to exchange rate volatilities its coefficient in the monetary rule is -0.12. So, when central bank faces with an exchange rate shock, chooses contractionary monetary policy. This result is consistent with the results from model simulations.