The Effect of Uncertainty Caused by Monetary and Exchange Rate Policies on Financial Stability: Markov Regime Switching Approach in Iran’s Economy

اقتصاد پولی مالی

Articles in Press, Accepted Manuscript, Available Online from 12 July 2025

Document Type: Original Article

DOI: 10.22067/mfe.2025.93017.1537

Authors

Abdollah Saeidi¹; Mohammad Ali Falahi^{* 2}; Hadi Esmaeilpour Moghadam,³

¹Department of Economics. Faculty of Economics and Administrative Sciences, Ferdowsi University of Mashhad, Mashhad, Iran

²Professor, Department of Economics, Faculty of Economics and Administrative Sciences, Ferdowsi University of Mashhad. Mashhad. Iran

³Assistant Professor, Department of Economics, Faculty of Economics and Administrative Sciences, Ferdowsi University of Mashhad, Mashhad, Iran

Abstract

A stable financial system plays a critical role in facilitating the flow of funds from savers to investors and optimal allocation of scarce resources to productive economic activities. Any disruption in the functioning of this system can jeopardize these essential objectives. Economic uncertainty, as a key factor affecting economic decision-making, has always been the focus of policymakers. This study aims to provide a comprehensive analysis by calculating an uncertainty index arising from Iran's economic policies (including monetary and exchange rate policies) during the period 1981–2022 using the GARCH model and the OECD’s ten-step methodology. Furthermore, the relationship between the economic policy uncertainty index and the financial stability index was examined using the Markov Switching model. Key variables affecting monetary policy uncertainty include interest rate, money supply growth rate, inflation rate, central bank independence, and government fiscal health, while the key variable for exchange rate policy uncertainty is the real exchange rate. The financial stability index was constructed using variables such as liquidity, capital adequacy ratio, bank credit to the private sector, deposit interest rates, stock market index, and exchange rate. The findings reveal that EPU1 primarily reflects domestic economic fluctuations, while EPU2 is more sensitive to international shocks like sanctions. During financial instability, external shocks dominate, whereas both domestic and external uncertainties pose threats during stable periods, highlighting the need for adaptive policy measures to maintain financial stability in Iran's economy."

Keywords

Exchange rate policy; monetary policy; financial stability; Uncertainty; Markov -Switching Model

References