Interactive Effects of Fiscal and Monetary Policy and Household Responses to Exchange Rates (TVP-FAVAR Approach)

Document Type : Research Paper

Authors

1 Professor of Mathematics, University

2 PhD Student in Economics, University

Abstract

This study examines the effects of household behavior along with fiscal and monetary policy makers on exchange rates. Due to Iran's institutional economic components and various internal and external economic and political shocks, various monetary and fiscal policy instruments have been used by the government and the central bank in recent years. In this context, this paper examines the impact of the composite index, which is the result of the interaction of monetary policy makers, fiscal policy makers and households, on the exchange rate over the time period 1989-2018 using the TVP-FAVAR model. Examining the response function of the exchange rate to the change in the interaction variable estimated as a result of monetary and fiscal policy shows the positive effect of the interaction variable on the evolution of the exchange rate, leading to a jump in this variable. As a result of fiscal dominance in the Iranian economy, the mechanism of removing the effects of fiscal indiscipline occurs through monetary policy, and as a result of non-compliance with the government's budget constraints and the consequent increase in liquidity, this leads to an increase in the exchange rate. Household decisions in the period of currency repression have a significant positive effect, but in the currency crisis, when there is a significant currency jump in the Iranian economy, they do not play a major role in currency fluctuations. Examining the impact of the interactive variable, which is the aggregation of all the above variables on the exchange rate, shows that the exchange rate always responds positively and steadily to monetary and fiscal policy fluctuations and household decisions in all the periods studied, except for the period of booming oil revenues. Monetary and fiscal policy coordination is more influenced by government fiscal discipline. Since the exchange rate is a nominal anchor in Iran, the positive response of the exchange rate to the interactive shocks of monetary and fiscal policies is obvious by estimation. Therefore, the role of government fiscal discipline in controlling inflation through the exchange rate channel is emphasized more than any other variable.
JEL Classification: C53, E44, F43

Keywords


Volume 56, Issue 3 - Serial Number 135
December 2021
Pages 555-587
  • Receive Date: 14 September 2021
  • Revise Date: 03 January 2022
  • Accept Date: 09 March 2022
  • First Publish Date: 09 March 2022