The Effect of the Optimal Monetary and Fiscal Policies on Major Macroeconomic Indexes in Iran: an Application of Optimal Control Theory

The purpose of the present paper is a quantitative determination of optimal monetary and fiscal policies under floating exchange rate regime for the country’s third development plan (2000-2004). For this purpose, first, a welfare loss function is designed in which penalized on the quadratic deviation of objective variables such as: economic growth, inflation rate, unemployment, current account and the ratio of government budget deficit to GDP from their optimal control algorithm “OPTCON”, the optimal values of government’s investment and consumption expenditures, tax revenues and money stock (liquidity) are calculated by minimizing the welfare loss function subject to a dynamic nonlinear system. The comparison between optimal monetary and fiscal policies with the Third Plan’s proposed macroeconomic policies shows the optimal values of liquidity, government consumption and investment are lower and the optimal values of tax revenues are greater than the proposed values in the Third Plan. Also, under optimal monetary and fiscal policies, the rate of economic growth, the ratio of budget deficit to GDP and current account will be better compared with the Third Plan’s proposed macroeconomic policies. The results of the present paper could help policy makers design fiscal and monetary policies of the Fourth Development Plan and the optimal values of instrument variables.