Asymmetric Effectiveness of Monetary Shocks During Oil Revenue Cycles: Case of Iran

Abstract

More recent research indicates that the effect of monetary policy is state-dependent. This paper conjectures that the impact of monetary shocks on output and inflation in the Iranian economy is contingent on state of the economy, reflecting the size of oil revenue streams, which closely approximates economic cycles. Limited access to international financial markets together with fiscal spillovers emanating from financing of government expenditures and fiscal deficit finance, in a fiscally dominant environment, are the main contributing factors in this respect. To address the state-dependent effectiveness of monetary shocks in the Iranian economy during the period 1990-2017, we utilized a two-stage nonlinear SVAR model. First, the monetary and fiscal shocks were identified by a short term zero-restriction method in which fiscal dominance was taken into account as an amplification mechanism for fiscal shocks. Then, we used a smooth transition auto regressive (STAR) method proposed by Auerbach and Gorodnichenko (2012) to decompose boom and bust oil revenue cycles. Finally, the asymmetric effects of monetary shock on output and inflation in expansion and contraction phases were analyzed by impulse response functions estimated using local projection method developed by Jorda (2005). Our findings demonstrate that the reactions of output and inflation to monetary shocks are asymmetric and state-dependent over oil revenue cycles. While the impact of monetary shocks on output is positive and significant only in the expansionary phases, the positive reaction of inflation to monetary shock is stronger and more persistent in oil revenue scarce periods rather than abundant ones.

Keywords

• monetary policy
• asymmetric
• fiscal dominance
• block-recursive identification