Economic Stability and the Central Bank: Rule or Discretion

Abstract

The history of monetary policy in Iran, judging by their performance in keeping the value of the currency, maintaining a steady growth in the Gross Domestic Product, faltering investment, show that monetary policy has not been a portrait of consistent successes, to say the least. It has been employed in an on-again-off-again manner rather than as a tool for proactive decision making. In this paper the author shows the simulation results for the GDP growth under a regime of fixed monetary rule under different assumptions Comparing the historical changes in the monetary base with a policy rule would highlight the benefits of a response rule. One could see wider fluctuations in the monetary base compare to what was warranted according to the response function. They also show that in most of the cases, monetary base moved the opposite of what should have been done according to the response function. That is, in most years, they reduced the money supply when they should have increased it and increased the money supply when they should have decreased it. At times, it seems that they made a wrong monetary policy and the next year, found their mistake and over compensated for the mistake by overshooting or undershooting