The Effect of Monetary Policy on Business Cycles in Iran Economy


President Deputy Strategic Planning and Control


Nowadays one of the most important issues in our economy, both from economic and political view is the link between monetary policy and business cycle fluctuations. Amongst the shocks related to the supply side, the shock of oil price is the important factor that has affected the world economy since the 1970s. This paper examines the effects of monetary policy and oil price shocks on the business cycle fluctuations by applying the factor augmented vector autoregressive approach, Bernanke (2005) … to compare the results with VAR models by using Iran quarterly data for the period 1988:Q2 to 2011:Q3, the FAVAR models explain the effects of monetary policy which are consistent with theory better than VAR models. The results demonstrate a small but significant impact of monetary policy on the business cycle fluctuations.


1- Armas, Adrian and Francisco Grippa (2005), "Targeting Inflation in a Dollarized Economy: The Peruvian Experience," Research Department Working Paper Series 538.
2- Bernanke, B. S., and Blinder, A. S. (1992), "The Federal Funds Rate and the Channels of Monetary Transmission," American Economic Review, 82(4).
3- Bernanke, B. S., and Mihov, I. (1995), "Measuring Monetary Policy," NBER Working Paper Series, Working Paper 5145.
4- Bernanke, B. S., Gertler, M., and Watson, M. (1997), "Systematic Monetary Policy and the Effects of Oil Price Shocks," Brookings Papers on Economic Activity, 1.
5- Baglioni, Fabio C., Carlo A. Favero. (1998), "Measuring Monetary Policy with VAR Models: An Evaluation," European Economic Review 42(6).
6- Bai, J. and Ng, S. (2002), "Determining the Number of Factors in Approximate Factor Models," Econometrica, 70(1).
7- Bernanke, B. S., Boivin, J., and Eliasz, P. (2003), "Measuring the Effects of Monetary Policy: a FAVAR Approach," Manuscript, Princeton University.
8- Bernanke Ben S., Jean Boivin, Piotr Eliasz (2004). Measuring the Effects of Monetary Policy: A Factor - Augmented Vector Autoregressive (FAVAR) Approach, NBER Working Paper 10220, National Bureau of Economic Research, Cambridge. 
9- Bernanke, B. S., J. Boivin and P. Eliasz (2005), "Measuring the Effects of Monetary Policy: A Factor Augmented Vector Autoregressive (FAVAR) Approach," Quarterly Journal of Economics 120 (1).
10- Cochrane, J. H. (1994), "Permanent and Transitory Components of GNP and Stock Prices," Quarterly Journal of Economics, 109.
11- Christiano, L., Eichenbaum, M., and Evans, C. (1996), "The Effects of Monetary Policy Shocks: Evidence from the Flow of Funds," Review of Economics and Statistics, 78(1).
12- Clarida, R., Gali, J., and Gertler, M. (2000), "Monetary Policy Rules and Macroeconomic Stability: Evidence and Some Theory," Quarterly Journal of Economics, 115.
13- Chauvet, M., and Potter, S. (2001), "Recent Changes in the U.S. Business Cycle," Staff Reports 126, Federal Reserve Bank of New York.
14- Canova, F., and De Nicolo, G. (2002), "Monetary Disturbances Matter for Business Fluctuations in the G7," Journal of Monetary Economics.
15- Diebold, F. X., and Rudebusch, G. D. (1996), "Measuring Business Cycle: a Modern Perspective," the Review of Economics and Statistics, 78.
16- Fabio C. Bagliano, and Claudio Morana, (2008), "Factor Vector Autoregressive Estimation: a New Approach," J Econ Interac Coord, 3.
17- Godfreind, M. and King, R. (1997), "The New Neoclassical Synthesis and the Role of Monetary Policy," NBER Macroeconomics Annual.
18- Gali, J., (2002), "New Perspectives on Monetary Policy, Inflation and Business Cycle," NBER Working Paper, No. 8767.
19- Hamilton, J. (1997), "Measuring the Liquidity Effect," American Economic Review, 87(1).
20- Hutchison, Michael M. and Walsh, C. (1998), "The Output-Inflation tradeoff and Central Bank Reform: Evidence from New Zealand," The Economic Journal, 108.
21- Hoggarth, G., Sorensen, S. and Zicchino, L. (2005), "Stress Tests of UK Banks Using a VAR Approach," Bank of England, Working Paper No. 282.
22- Ireland, P., (2001), "Money's Role in the Monetary Business Cycle," NBER Working Paper, No. 8115.
23- Kose, M. A., Otrok, C., and Whiteman, C. H. (2003), "International Business Cycles: World, Region, and Country-Specific Factors," American Economic Review, 93(4).
24- Korenok, O., Radchenko, S. (2004), "The Role of Permanent and Transitory Components in Business Cycle Volatility Moderation," Manuscript, Rutgers University.
25- Korenok, O., Radchenko, S. (2004), "Monetary Policy Effect on the Business Cycle Fluctuations: Output vs. Index Measures of the Cycle," Manuscript, Rutgers University
26- Leeper, E. M., Sims, C. A., and Zha, T. (1996), "What Does Monetary Policy Do?," Brookings Papers on Economic Activity, 2.
27- Lahura, E. (2010), "The Effects of Monetary Policy Shocks in Peru: Semi-Structural Identification Using A Factor – Augmented Vector Autoregressive Model," Banco Central De Reserva Del Peru, Working Paper Series.
28- McConnell, M. M., and Perez-Quiros, G. P. (2000), "Output Fluctuations in the United States: What has Changed since the Early 1980s?," American Economic Review, 90.
29- Minella, A. (2003). Monetary Policy and Inflation in Brazil (19752000): A VAR Estimation.  Revista Brasileira de Economia, 57.
30- Mumtaz, H. & Surico, P. (2009), "The transmission of International Shocks: A factor-Augmented VAR Approach," Journal of Money, Credit and Banking, 41(1).
31- Orr, Adrian and David Rae (1996), "Exchange Rate Behavior under Inflation Targets," The National Bank of New Zealand Limited, Financial Research Paper No.6.
32- Sims, C. (1992). Interpreting the Macroeconomic Time Series Facts: The Effects of Monetary Policy. European Economic Review, 36(5).
33- Sims, C. A. (1998), "The Role of Interest Rate Policy in the Generation and Propagation of Business Cycles: What Has Changed Since the '30s? Conference Series, 42. Boston: Federal Reserve Bank of Boston.
34- Stock, J. and Watson, M. (2002). Forecasting Using Principal Components from a Large Number of Predictors. Journal of the American Statistical Association, 97(460).
35- Stock, J. and Watson, M. (2005). Implications of Dynamic Factor Models for VAR analysis. NBER Working Paper 11467.
36- Shibamoto, Masahiko. (2007). An Analysis of Monetary Policy Shocks in Japan: A Factor Augmented Vector Autoregressive Approach. The Japanese Economic Review 58(4).
37- Temin, P. (1998), "The Causes of American Business Cycles: an Essay in Economic Historiography," Conference Series, no. 42, Boston: Federal Reserve Bank of Boston.
38- Taylor, J. (2000), "The Monetary Transmission Mechanism and the Evaluation of Monetary Policy Rules," Working Papers Central Bank of Chile 87, Central Bank of Chile.
39- Uhlig, H. (2008), "Comments on has the Euro Changed the Monetary Transmission?," In NBER Macroeconomics Annual. NBER.
40- Walsh, Carl E. (2010), "Monetary Theory and Policy," 3rd ed. Cambridge: MIT Press.