International Journal of Nonlinear Analysis and Applications

Examining external shocks and welfare losses with emphasis on monetary rule

Document Type : Research Paper

Authors

1 Faculty of Management, Arak Branch, Islamic Azad University, Arak, Iran.

2 Department of Management, Arak Branch, Islamic Azad University, Arak, Iran.

3 Department of Economics, Qazvin Branch, Islamic Azad University, Qazvin, Iran.

Abstract

The economies of countries may face a variety of shocks driven by various factors, leading to high economic and non-economic costs. Therefore, it is essential to investigate different external shocks in the economy, as well as how these shocks can be managed. Accordingly, this study aims to investigate the effect of external shocks (global oil price shock, global inflation, and foreign interest) on macroeconomic variables. This study also seeks to examine a type of monetary policy consistent with Iran's economic conditions. Focusing on the New Keynesian School of thought, this study develops a stochastic dynamic general equilibrium (SDGE) model compatible with the situation of Iran. This model is comprised of these sectors: household, oil, non-oil, import, final goods production, and government. After performing linearization procedures, this study analyses the shocks responses and results, with a focus on the three rules of monetary policy (headline inflation, core inflation targeting, and exchange rate) for the purpose of optimal monetary policy. Studies show increasing number of variables being investigated, but in some cases, this trend has quickly reached stability, yielding an appropriate pattern for adopting the optimal policy. However, in some cases, including GDP, we experience a decreasing response of variables regarding the adoption of headline inflation and exchange rate policies. Consequently, it is necessary to evaluate the appropriate policy. Regarding the deadweight loss in relation to the three monetary rules, the findings of this study show that in the face of volatilities studied, household deadweight loss is affected more strongly by headline inflation rule than the other two policies. In contrast the exchange rate rule plays a less important in the amount of deadweight loss.

Keywords

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International Journal of Nonlinear Analysis and Applications
Volume 14, Issue 2
February 2023
Pages 111-123
  • Receive Date: 03 November 2021
  • Revise Date: 08 January 2022
  • Accept Date: 11 February 2022