Fiscal dominance and fiscal policy in Iranian economy: A Dynamic Stochastic General Equilibrium approach

Based on studies in Iranian economic literature, fiscal shocks are the most important sources of business cycles. Dynamic Stochastic General Equilibrium model is the best tool to understand the mechanism of different shocks propagation, especially fiscal shocks, and its final effects on macroeconomic variables. This study presents a DSGE model for fiscal dominance modeling and mechanism of fiscal shocks propagation analysis in Iranian economy. The important property of this model is that the relationships between government as fiscal policy maker and central bank as monetary policy maker are under fiscal dominance.The parameters of the model are estimated with Bayesian approach. To show the dynamics of important economic variables to different shocks, especially fiscal shocks, we present impulse response functions. The results show that an independent expansionary fiscal policy leads to a business cycle in real economy along with increasing inflation. However, an expansionary fiscal policy, which depends on oil shock, leads to an increasing inflation at first stage and decreasing after on along with increasing output. This model and its results can provide a good understanding of the mechanism of fiscal shocks propagation in Iranian economy and its final effects on macroeconomic variables. These results are useful for managing business cycles and stabilization policy in Iranian economy.