Exchange Rate Policy in Stabilizing Exchange Rate Misalignment in Iran

Fluctuations and instability in key economic variables, including economic growth, productivity, international trade, prices, and government expenditure, can lead to deviations of the real exchange rate from its equilibrium level. Furthermore, external factors such as multi-rate currency systems and financial sanctions can exacerbate these deviations. These exchange rate misalignments exert significant impacts on investment, economic growth and development, trade flows, balance of payments equilibrium, optimal resource allocation, and other crucial economic variables and indicators. Given the historical prevalence of exchange rate fluctuations within the Iranian economy and the profound impact of these deviations on the country's economic performance, this study investigates the determinants of the real exchange rate and the mechanisms through which deviations arise. Subsequently, it examines the potential impact of exchange rate policies, specifically exchange rate unification, on mitigating these deviations from the equilibrium level. To this end, utilizing time series data on key macroeconomic variables spanning the period from 1975 to 2020, an empirical model of real exchange rate deviation is estimated employing the Vector Autoregression (VAR) method. The empirical findings demonstrate a significant response of exchange rate deviations to the implementation of exchange rate policies, particularly through exchange rate unification or improvements in institutional quality within the specified timeframe. The overall results suggest that an optimal exchange rate policy, achieved through exchange rate unification, contributes to dampening real exchange rate deviations and fostering greater exchange rate stability.