Modeling the Relationship between Exchange Rate and other Macroeconomic Variables: Case Study of Iran (BVAR Approach with SSVS Prior)

Abstract

The exchange rate is an important economic variable which affects other macroeconomic variables through different channels. This article estimates the effects of exchange rate shocks on macroeconomic variables of Iranian economy by applying Bayesian VAR method and using different prior functions like Minnesota and SSVS. The endogenous variables of the model are market exchange rate, monetary base, GDP deflator and GDP. The only exogenous variable of the model is the oil revenue of Iran. According to the result of the model, the BVAR-SSVS method offers the most precise forecast and OLS method has the least forecast power. At last, using the impulse response function, the effects of one unit shock in exchange rate on other macroeconomic variables has been assessed. The most important finding of this article is that, based on our data for Iranian economy, currency devaluation causes GDP to decline.

Keywords

• exchange rate
• bayesian var
• ssvs prior function
• impulse response function