Investigation of the Effect of Exchange Rate Volatality on Economic Welfare and Determination of Appropriate Monetary Policy

Exchange rate volatility and its resulting uncertainty affects many macro variables, activities, economic conditions as well as economic welfare. This paper attempts to investigate the effect of exchange rate volatility on economic welfare using a macro-econometric model. Since measuring GDP does not always mean a higher welfare for the society, first a more appropriate index for measuring welfare is introduced, then the effect of exchange rate volatility on economic welfare is calculated using the designed macro-econometric model. With the assumption of no exchange rate volatility, economic welfare again is measured and the results are compared. Our findings show that exchange rate volatility results in lower economic welfare, which means ignoring it in the model would mis-specify it and therefore dis-array its findinings. At the end, the effects of implementing two different monetary policy rules in order to improve the declined economic welfare, due to exchange rate volatility, is examined and compared. The findings show that implementing the stability of banking profit rates in the era of exchange rate volatility is a better monetary policy.