Introduction and Estimation of Monetary Conditions Index for Iran's Economy Using Johansson-Josilius Error Correction Method

Determining the monetary policy rule and identifying expansionary and contractionary policies is of particular importance to monetary policymakers. Monetary conditions index as an average weight of effective money transfer channels can play an important role in identifying expansionary and contractionary monetary policies. Therefore, in this article, the index of monetary conditions along with determining the amount of effectiveness of each of the channels of monetary policy in the process of monetary policy transfer is estimated. Such an index is the middle goal of the monetary policymaker in the medium term, and in this paper, the index is estimated based on the two variables of price target and demand, using the Johansson-Josilius error correction method. The results show that assuming inflation is targeted by the central bank and using the criterion of mean square error, the price equation to predict inflation is a more appropriate equation to determine the index of monetary conditions for the Iranian economy. In addition, the index designed in this study shows that the exchange rate channel has the highest weight among the channels affecting the price level in the Iranian economy.