Analysis of Exchange Rate Policy in the Iranian Economy and Proposing its Reform Solutions

Document Type : Original Article

Authors

1 PhD in Economics, Post-doc Researcher, Isfahan, Iran

2 Associate Professor, Faculty of Administrative Sciences and Economics, University of Isfahan, Isfahan, Iran

3 PhD in Economics, Center of Excellence for International Economics, Faculty of Administrative Sciences and Economics, University of Isfahan, Isfahan, Iran

10.48308/jem.2024.234663.1892

Abstract

The real exchange rate reflects the level of competitiveness in the international market. High volatility of this variable indicates economic instability, which hinders rational decision-making and direction for economic actors. Therefore, policymakers strive to minimize the fluctuations of this variable as much as possible. With the sanctions and the resulting damages to various sectors of foreign trade, the fluctuation of the real exchange rate has a greater importance for the Iranian economy compared to other economies. Therefore, choosing an appropriate policy plays a significant role in the stability of the country's economy. Although the stability of the exchange rate has been mentioned in the sixth and seventh development plans, no specific rule has been mentioned to achieve it. Therefore, in this study, two policies, inflation-based exchange rate rule and the pattern including interest rate, are evaluated First, the modified Edwards model (1989) is estimated by 1960-2020 data. Then, in order to evaluate the impact of inflation shocks and interest rates on the behavior of the real exchange rate, impulse response function analysis is also used. The results indicate that inflation shocks have long-term effects on the real exchange rate, and therefore, the occurrence of an exogenous inflation shock quickly leads to a deviation of the future exchange rate from its equilibrium level. On the other hand, according to the impulse response function of the interest rate, the effects of interest rate changes are adjusted at a slower pace, and the exchange rate returns to its equilibrium level. Therefore, adopting a rule-based exchange rate policy based on inflation targeting can help achieve the desired goals of the country's development plans. 

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References

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