International Journal of Nonlinear Analysis and Applications

The effect of currency shock and monetary policy of the central bank on the production gap during business cycles: LSTAR threshold model approach

Document Type : Research Paper

Authors

1 Department of Economics, Central Tehran Branch, Islamic Azad University, Tehran, Iran

2 Department of Theoretical Economics, Allameh Tabatabai University, Tehran, Iran.

3 Department of Environment and Natural Resources Engineering, Parand Branch, Islamic Azad University, Parand, Iran

Abstract

This study aimed to explain the effect of currency shock and the monetary policy of the central bank on the production gap during business cycles. A model with a threshold approach (LSTAR) was used based on the seasonal data of the Iranian economy from April 2001 to July 2019. According to the statistical tests related to the correct specification of the model, the currency shock rate is a threshold variable for changing the coefficients as its function. The results showed that the central bank intervention and the oil shock had more effects on the production gap. The nature of production in Iran's economy is oil, and its booms and busts are synchronized with the booms and busts of oil income. The injection of high oil revenues and the experience of high economic growth increase the GDP growth and reduce the production gap due to the low currency shock rate. The continuation of economic growth in the upper stages increases investment in production, decreasing the production cost and gap. In addition, the effect of currency shock increases with the foreign exchange interventions of the central bank and crossing the threshold and entering the non-linear sector. In other words, policymakers have tried to control the growth of currency shock by more reaction to the growth of the exchange rate. However, the reaction to exchange rate deviations decreases after crossing the threshold. Therefore, controlling the exchange rate becomes more robust with the increase of its growth rate in foreign exchange interventions.

Keywords

[1] K. Hojabrkiani and S.Y. Abtahi, Testing new keynesian views on the asymmetric effects of monetary shocks on production in the Iranian economy using markov regime rotation models, J. Macroecon. 8 (2008), no. 30, 123–144.
[2] A. Lopez-Villavicencio and V. Mignon, Exchange rate pass-through in emerging countries: do the inflation environment, monetary policy regime and central bank behavior matter?, J. Int. Money Finance 79 (2017), 20–38.
[3] R. Mirdala, Exchange rate pass-through to consumer prices in the European transition economies, Procedia Econ. Finance 12 (2014), 428–436.
[4] T.J. Sargent and P. Surico, Monetary policies and low-frequency manifestations of the quantity theory, No. 26. External MPC Unit Discussion Paper, 2008.
International Journal of Nonlinear Analysis and Applications
Volume 14, Issue 6
June 2023
Pages 281-289
  • Receive Date: 08 April 2022
  • Revise Date: 19 May 2022
  • Accept Date: 30 July 2022