The time inconsistency of monetary policies and its effect on the exchange rate fluctuation in Iran

The concept of time inconsistency refers to the difference between optimality based on the past and the future. The purpose of this paper is to investigate the time inconsistency of monetary policies regarding the exchange rate in the Iranian economy during the period of 1989-2017. This period is broken down into four sub-time periods to evaluate the effects of that inconsistency along with the deviations in the exchange rate. In order to estimate the model parameters, the Generalized Method of Moments (GMM) has been used. Through differentiation of the policy for exchange rate and its effective factors, it is found that inflationary bias in the first and the second periods of this study has been less than that in the third and the fourth periods. Also, currency deviations have led to an increase in the exchange rate volatility due to instability in monetary policies and the inflation expectations of individuals.