Dynamics of Deflation in Iran In Behavioral and Conventional New Keynesian Models

This study investigates the dynamics of inflation in response to a contractionary monetary policy shock within the Iranian economy, modeled as a one-standard-deviation reduction in the money supply. Using both a conventional New Keynesian framework and a limited-horizon model incorporating agents' learning, the analysis evaluates the immediate and long-term impacts of such a policy on overall inflation and its cyclical and trend components. We using seasonal data from the Iranian economy covering the period 1988:2-2023:1 ,the results reveal that contractionary monetary shocks lead to an initial decline in all inflation components. Over time, inflation fluctuations adjust as agents gain information about monetary policy, with inflation converging toward its stable equilibrium. However, the magnitude and persistence of these effects differ between the two models. The limited-horizon model exhibits smaller inflation fluctuations but greater persistence of monetary shocks compared to the New Keynesian model, attributed to slower agent learning and gradual adjustment of trend inflation deviations. The study also highlights variations in the central bank's policy responses under the two frameworks. In the limited-horizon model, the central bank's reactions to cyclical and trend inflation deviations are less aggressive than in the New Keynesian model. These findings suggest that disinflation efforts can be achieved with less aggressive policy responses when agent learning and gradual adjustment processes are considered.