The Effect of Monetary Policy on Macroeconomic Stability in Iran In Behavioral and Conventional New Keynesian Models

Document Type : Research Paper

Authors

1 Department of Economics, Faculty of the Social Sciences and Economics, Alzahra University, Tehran, Iran

2 Department of Economics ,,Faculty of the Social Sciences and Economics, Alzahra University, Tehran, Iran;

3 Department of Economics . Faculty of Economics, Allameh Tabataba'i University, Tehran, Iran

Abstract

In this article, we have evaluated the capability of several New Keynesian models with behavioral characteristics in forecasting the effects of a monetary policy shock. We have considered the assumption of bounded rationality, taking into account agents' learning and finite horizon planning. The estimation of the models was conducted using the Bayesian approach within the framework of the dynamic stochastic general equilibrium. We used seasonal data from the Iranian economy covering the period 1988:2-2023:1. Our results indicate several important findings. Firstly, the New Keynesian model, which incorporates finite horizon planning, is more compatible with the data. Secondly, we found that in response to a monetary shock, finite horizon models exhibit less fluctuations and are more persistent compared to the Canonical New Keynesian model. This is due to the slow learning of agents from past experiences. As a result, the central bank reacts less aggressively to inflation and output fluctuations in finite horizon models compared to the Canonical New Keynesian model. Overall, our findings suggest that incorporating bounded rationality and finite horizon planning in New Keynesian models improves their ability to forecast the effects of monetary policy shocks in the Iranian economy.

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History

  • Receive Date: 15 January 2024
  • Revise Date: 04 February 2024
  • Accept Date: 14 February 2024

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