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

اقتصاد پولی مالی

Article 1, Volume 25, Issue 16, October 2018, Pages 1-32   

Document Type: پژوهشی

DOI: 10.22067/pm.v25i15.53296

Authors

Ebrahim Gorji Bandpi^* ; Farzaneh Anvari Rostamkolaii

University of Tehran

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

References

[1] Anders,walter. (2008). Econometric Analysis of Time Series with Applied Approach ", Vol. I, Translated by Mehdi Sadeghi Shahedani and Saeed Shalapur, First Edition. (in Persian)

[2] Barro, R.J., “Long Term Contracting, Sticky Prices and Monetary Policy”, Journal of Monetary Econometrics 3, July 1977.

[3] Barro, R.J., “Rational Expectations and Role of Monetary Policy”, Journal of Monetary Econometrics 5, January 1979.

[4] Barro, R.J., “Unanticipated Money Growth and Unemployment in the United States”, American Economic Review, Vol67, March 1977.

[5] Barro, R.J., “Unanticipated Money, Output and the Price Level in the United States”, Journal of Political Economy, August 1978.

[6] Baxter, M. and R. g. King, “Measuring business Cycles approximating band-pass Filters for economic time series”, Review Economics and Statistics, November 1999.

[7] Bergman, u., M. Bordo and L. Jonung (1998). "Historical Evidence on Business Cycles: The International Experience". Working Paper Series in Economics and Finance.

[8] Bordo, M. D. (1984). “The Gold Standard: The Traditional Approach.” In M. D. Bordo and A. J. Schwartz, eds., A Retrospective on the Classical Gold Standard, 1821–1931. Chicago: University of Chicago Press.

[9] Burns, Arthur F. and Weseley C. Mitchel.(1947).” Measuring Business Cycles”. NBER.

[10] Casares, M. (2001)."Business Cycle and Monetary Policy Analysis in a Structural Sticky Price Model of the EURO Area", Working Paper, NO. 49, ISSN ,1561-0810.

[11] Central Bank of the Islamic Republic of Iran (2014), Economic Report and Balance Sheet of the Bank in different years. (in Persian)

[12] Chatterjee, S. (2000). “From Cycles to Shocks: Progress in Business-Cycle Theory”, Federal Reserve Bank, Philadelphia.

[13] Chen, Jie and Zhu, Aiyong, “The relationship betweenhousing investment andeconomic growth in China:A panel analysis using quarterlyprovincial data”, Department of Economics, Uppsala University, Sweden, 2008.

[14] Chin, D., Geweke, J. and Miller, P., “Predicting Turning Points”, Federal Reserve Bank of Minneapolis Research Department Staff Report 267, June2000.

[15] Cooley, Thomas F., and Gary D. Hansen (1989), “Inflation Tax in a Real Business Cycle Model,” American Economic Review 79, no. 4.

[16] Dela Torre,M., "A study of small open economy with non-tradable goods", North Western University, 1997.

[17] Ebrahim,Gorji,Bandipi,Marjan,Ghavami&Yazdan,Goodarzi,Farahani. (2014). "The Causes of Business Cycles in Iran and Solutions Out of It." New Economic Theories. (in Persian)

[18] Ebrahim,Gorji,Bandipi,Masoumeh,Alipourian,Hossein,Sarmadi,Masoumeh,Alipourian&Hossein,Sarmadi. (2010)."The Impact of the Globalization of the Economy on Employment in Iran (and Some Developing Countries.") Knowledge and Development. (in Persian)

[19] Ebrahim,gorji,shima,madani. (2005). The evolution of analyzes of macroeconomic theories, the Institute for Commercial Studies and Research. (in Persian)

[20] Ebrahim,gorji,shima,madani. (2009). Macroeconomic Dynamics (Growth Theories), Samt Publishing, First Edition. (in Persian)

[21] Estrella, A. and Mishkin, F. “Predicting U.S: Recessions: Financial Variables as Leading Indicators.” The Review of Economics and Statistics, Vol. 80, No. 1, 45-61, 1998.

[22] Farrell, J. (2003)."Monetary Policy and Business Cycle Analysis in an Optimizing Model with Expectations Lags", Economics Section, Hull University & Julian Hodge Institute of Applied Macroeconomics.

[23] Filardo, A.J., “The 2001 US recession: what did recession prediction models tell us?” BIS Working Papers 148, Monetary and Economic Department of the Bank for International Settlements, 2004.

[24] Fisher, I., “Booms and Depressions”, London: Alien and Unwin, 1933.

[25] Gali, J. (2002)."New Perspectives on Monetary Policy, Inflation, and the Business Cycle”,NBER Working Paper, No. 8767.

[26] Gali, J. (2008)."Monetary Policy, Inflation, and the Business Cycle", Princeton University Press and copyrighted.

[27] Gaudreault, C. and Lamy, R, “Forecasting a One Quarter Decline in U.S Real GDP with Probit Models”, Working Paper 2002-05. Department of Finance, Economic and Fiscal Policy Branch,2001.

[28] Glasner, D., “Business Cycles and Depression: An Encyclopedia”, Garland Publishing, Inc, 1997.

[29] Gorji,Ebrahim. (2014)."Challenges in the Contemporary Macroeconomic Perspectives", Tehran University Press, Second edition. (in Persian)

[30] Haltmaier, J., “Predicting Cycles in Economic Activity”, International Finance Discussion Paper Number 926. Board of Governors of the Federal Reserve System, 2008.

[31] Hamberg,ULF and David Verstandig, "Applying Listic Regression Models on Business Cycle Prediction",www.essay.se, 2008.

[32] Harding, D. and Pagan, A. (2005). “A suggested framework for classifying the modes of Cycle Research” Journal of Applied Econometrics, 20.

[33] Huffman, Gregory W. 1994.” A Primer on the Nature of Business Cycles.” Economic Review, First Quarter. Pp. 27-41

[34] Komeijanie,Akbar,Ebrahim,Gorji,Bandpei&Alireza,Eghbali, (2014);"Estimating a New Model of Political Business Cycles: Studying Iran". Business Journal 1, 71: 1-34. (in Persian)

[35] Korenok, O. and S. Radchenko. (2004). "Monetary Policy Effect on the Business CycleFluctuations: Output vs. Index Measures of the Cycle".

[36] Korotayev, A. V., and S. V. Tsirel. "A spectral analysis of world GDP dynamics: Kondratieff waves, Kuznets swings, Juglar and Kitchin cycles in global economic development, and the 2008–2009 economic crisis." Structure and Dynamics 4, no. 1, January 2010.

[37] Kydland, F.E. and E.C. Prescott, “Time to Build and Aggregate Fluctuations”, Econometrica, November 1982.

[38] Kydland, F.E., and Precott, E.C. (1990). “Business Cycle: Real Facts and a Monetary Myth”, Federal Reserve Bank of Minneapolis Quarterly Review, 14(2)

[39] Kydland, Finn.E and E.C. Prescott, Edward. 1990.”Business Cycles: Real facts & a Monatary Myt”, FRB Mineapolis, Quarterly Review.

[40] Layton, Allan P. and Masaki Katsuura, "Comparison of regim switching, probit and Lit models in dating and forcasting US business cycles", International Journal of Forcasting, No.17, 2001.

[41] Leamer, E.E. “Housing is the Business Cycle”, Working Paper 13428. National Bureau ofEconomic Research, Cambridge, 2007.

[42] Lucas, R. E."Models of Business Cycles ", Oxford: Basil Blackwell, 1987.

[43] Lucas, R. E."Studies in Business Cycle Theory", Oxford: Basil Blackwell, 1981.

[44] Lucas, R.E. (1977). “Understanding Business Cycles”, In Stabilization of the domestic and international economy, ed. Karl Brunner and Allan H. Meltzer, Carnigie-Rochester Conference Series on Public Policy 5, Amsterdam: North Holland; pp. 7-29.

[45] Lucas, R.E. “Some International Evidence of Out-inflation Tradeoffs”, American Economic Review, June 1973.

[46] Lucas, Robert E. (1976). “Econometric Policy Evaluation: A Critique,” Carnegie–Rochester Conference Series on Public Policy, 1, 19–46.

[47] Maddala, G.S., "Limited-Dependent and Qualitative Variables in Econometrics", Cambridge university press,1983.

[48] Male, R. (2010)."Developing Country Business Cycles: Characterizing the cycle", Working Paper, NO. 663. ISSN 1473-0278.

[49] Mankiw, N. G., “Real Business Cycles: A New Keynesian Perspective”. Journal of Economic Perspective, No. 3, 1989, pp. 79-90.

[50] McDermott, C.J., and Scott, A. (1999). “Concordance in Business Cycles”, Reserve Bank of New Zealand Working Paper, No. G99/7

[51] McGuckin, R. (2001)."Business Cycle Indicators handbook", The Conference Board.

[52] Millard, Stephen P, and Wells, Siomon, “The role of asset prices in transmitting monetary and other shocks”, 2003, Working Paper no. 188.

[53] Mishkin, F.S., “Does Anticipated Monetary Policy Matter? An Econometric Investigation”, Journal of Political Economy, February 1982.

[54] Mukoyama, T. (2006). "Recent Developments in Business Cycle Theory", Concordia University and University of Virginia, Written for an undergraduate macro lecture at University of Tokyo.

[55] Prescott, E. "Theory ahesd of business cycle measurement", Federal Reserve Bank of Minneapolis Quarterly Review, Vol.10,1986.

[56] Shakeri, Abbas. (2008). Macroeconomics: Theories and Policies, Vol. I, Pars Journal, First Edition. (in Persian)

[57] Shakeri, Abbas. (2008). Macroeconomics: Theories and Policies, Vol. II, Pars Journal, First Edition. (in Persian)

[58] Sims, Christopher. (1980). “Macroeconomics and Reality,” Econometric 48, no. 1.

[59] Smets, Frank, and Raf Wouters. (2003). “An Estimated Dynamic Stochastic General Equilibrium Model of the Euro Area”, Journal of the European Economic Association 1, no. 5

[60] Teymur, rahmani. (2011). Macroeconomic, baradaran publishing,Tehran. (in Persian)

[61] Train, Kenneth E., "Discrete Choice Methods with Simulation", Cambridge University press, Second edition,2009.

[62] Valentino, L.M. and Dauten, C.A.(1987).” Business Cycles & Forecasting”, Fedral Reserve Bank of Philadephia, issue Mar, pages 27-37.

[63] Wen, Yi.(1999).”Business Cycle Effects of Seasonal Shocks”, NBER, Ithaca