Exchange Rate Corridor Target Currency Regime in the Iranian Economy

Sustained fiscal deficits and external shocks have affected the monetary and foreign exchange markets, leading to periodic increases in inflation, the formation of negative policy rates, the transfer of financial resources from the real sector to the financial sector, a reduction in the ratio of investment to GDP, an acceleration of speculative demand in the asset and foreign exchange markets, and rapid depreciation in the foreign exchange market. Therefore, the inflation target is inevitably replaced by the exchange rate target within a flexible corridor to improve financial stability, while the interest rate loses its role as a nominal anchor. In this study, the effects of real, fiscal, monetary and BOP shocks on the exchange rate corridor were statistically estimated using the policy vector auto-regression (PVAR) method to calculate the relationship between exchange rate growth and macroeconomic variables. In addition, the optimal response of the exchange rate corridor to the shocks of the contingent state variables is also investigated. The result of the Impulse Response Function (IRF) shows that higher inflation, international reserves, and the ratio of the net claim on the government to the monetary base (MB) cause the upper band of the exchange rate corridor to widen, and conversely, a reduction in the volatility of real interest rates, the ratio of the net claim on banks to MB, and the ratio of gross investment to GDP could narrow the EXR corridor.JEL Clasification: E52, C32.