The Analysis of Effect of the Central Bank Independence on Reduction of Output Variances in Iran (Application of GARCH Model and VAR Approach)

In this paper, an attempt is made to study the effect of independence of the Central Bank of I.R.I-which is per se manifested as an institutional paradigm for monetary policy making-on reduction of output variances and in turn on attaining the macroeconomic stability in a historical and experimental perspective for the span of 54 year i.e. the study period of 1961-2014, pro rata. For this task and to estimate the model, we have applied the Vector Auto Regressive (VAR) Method. Similarly to measure the conditional variances of output which de facto may predicate the economic fluctuations, we have utilized the Generalized Autoregressive Conditional Heteroscedasticity Model, Ipso facto. Meanwhile, we have used the "Medium Index" which is a new combined index, comprising of four conventional indices to postulate that the Central Bank of I.R.I had only experienced the relative independence during the period of 1961 to 1982, Quid pro qua. The results prima facie indicate that the effect of Central Bank independence on output variances is negative but significant and if the degree of independence increases, the fluctuation of output will diminish and the economy may observe more stability in toto. Thus, the Variance Decomposition Test indicates that, though the degree of explicability of the Central Bank independence variable for affecting on output variances is very low in the initial phase, but in the span of time and with respect to inefficiency of other explanatory factors, the plausibility of this variable has increased tremendously and it has played more crucial role on stability of output, Sine qua non.
Besides, the effects of fiscal policy of government and degree of openness of the economy on output variances are positive and opposite to the Central Bank Independence variable, so that consecutively, they may accelerate the fluctuation of output, Sui generis.