The Role of the Central Bank in Creating Business Cycles in the Iranian Economy

Document Type : پژوهشی

Authors

• Ebrahim Gorji Bandpi
• Farzaneh Anvari Rostamkolaii

University of Tehran

https://doi.org/10.22067/pm.v25i15.53296

Abstract

This paper investigates the role of the central bank and monetary policy in the occurrence of the business cycles in Iran’s economy. This is important since the effects of monetary policy on the business cycle and its dynamics are the main stage in understanding the role of financial markets in the economy. Therefore, in this study, using the quarterly data from, 1999-2013 the cycles in GDP and liquidity have been elicited (with the help of economic filters); then, using vector autoregressive model, it is shown that fluctuations in liquidity are leading the fluctuations in production.
The most important and crucial issue among modern economics is the existence of commercial cycles or economic fluctuations. The emergence of such business cycles, which in many cases caused problems for the economies and created a period of unintentional inflationary or recessionary events which could itself lead to other adverse economic conditions. Consequently, it seems the study of this phenomenon and the causes of its creation as well as finding options to deplete those problems are the most concerning issues of economic policies in every country. Commercial cycles are fluctuations which are defined in terms of frequency periods of boom and recession. Economic activities usually consist of two stages, recession and boom. When production and employment decrease and lead to poverty, they reduce the welfare and lower the living level of people; hence, it means that economic activities are in recession. Additionally, when production and employment rise, it brings about welfare and increases society’s living quality; this means economic is about to get better or boom. Although, these cycles occur frequently, none of two cycles are similar to each other. During later decades recognition of causes, predictions and economic fluctuations are the most important issues of macroeconomic and policy making economists. Among commercial cycles, usually parameters like production, employment, real income and real sale level decrease and increase together. On the other hand, some economic parameters before empowering a cycle are considered as pioneer indices, which indicate the existence of an economic cycle in future. Among these parameters, we can name those that are cooperating in changing of money, credits, crucial prices, order volume in production parts, personal contracts, number of started buildings and number of working hours. It can be said that, a group of economists believe that economics essentially has a problem which for some reasons will lead to commercial cycles. On the other hand, another group of them believe that some external intruding will lead to the creation or at least increase of these cycles. According to the second group, economics essentially has stability and since the external intruding of government, banks, and other sources do not exist, economics will not experience any commercial cycle, and as a result, the essential and crucial question is whether it is possible to get rid of the cycles.
Generally, we can study the reasons of growths in real volume of country’s economic activities in two aspects of changes in demand and supply. The considerable point is that, the existence of stability in a country’s economy could be useful in various aspects and essentially one of the duties of governments and planning systems is providing economic stability. Thus, with the recognition of fluctuation’s structure and cycles in economy, we should try to control and decrease the intensity of them. Severe economic fluctuations or cycles are natural, and instability growths in economy, households, and economic firms cannot make a bright prediction of future. In times of recession or moving towards a recession, unemployment has increased and production has declined, and some production units may even be out of business and prices are falling. What is important is to know what initially creates prosperity and then, after a period of economic activity, it will lead to slowdowns and stagnation. In other word, it seems that in economic cycles we must look for the reasons of appearance, duration, and power of these fluctuations. There are various theories and reasons which lead to commercial cycles in macroeconomic literatures. Some of these theories say that the origin of fluctuations and commercial cycles is in policies of the demand side. The theory of Keynesians, the monetary (Chicago School), and the theory of rational expectations and its subcategories, including the new classics (monetary branches) and the new Keynesians, are among these theories.
According to some theories, commercial cycles are related to supply spectrum theory. One of these is the Real Commercial Cycle Theory (RBC), which argues that fluctuations and business cycles are explained by the volatility of real variables in the economy . Whether the central bank can pursue active economic stabilization policies and, on the other hand, whether anti-cyclical monetary policies can be effective in controlling business cycles is a great help for economic policy-makers and policy makers. The answer to these questions will be very helpful to economic regulators and central banks’ policy makers. Consequently, it seems that the recognition and understanding of commercial cycles will be the first step in retrieving the role of central bank, and as a result, they will be considered in designing stability policies.
Based on the obtained results, on average, 23 periods are observed, with peak periods, the rate of liquidity change was about 9 months (6 months) from the peak of the level of economic activity.



Results and discussion
Variance Dissection (VD)
The results of the dissection of variance in Table 10 show that in the short term (about three cycles ), the explanatory power of the growth of government expenditures from periods of stagnation and boom is higher than the explanatory power of liquidity growth, but, in the medium and long term, liquidity growth has a greater potential for expanding business cycles and periods of recession.
Conclusion
In this paper, we tried to answer the above question using a theoretical explanation and designing a self-regression vector (VAR) model in order to analyze the experimental effect of this relationship. Based on the results, it is found that, on average, using 23 cycles, the peak of interest rates was about 9 months away from the peak of economic activity. This could indicate that fluctuations and changes in the rate of liquidity growth as an indicator for monetary policy in the Iranian economy are one of the factors that trigger business cycles in Iran's economy. To evaluate the dynamics among the model variables, the action-response functions were used. The results reflect the negative reaction of the business cycle to inflation. In other words, the inflation rate has a positive and significant effect on the duration of the recession, so by increasing it by one percent, the length of the recession or the risk of withdrawal from this period will be reduced. Therefore, with rising inflation, the length of the recession in Iran will increase.

Keywords

• Business cycle
• Liquidity
• Monetary policy
• vector autoregressive model VAR

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