Simulation and Forecasting of Optimal Monetary Policy with a Monte Carlo Approach

Document Type : RESEARCH PAPER

Authors

1 PhD Student of International Economics, Department of Economics, Faculty of Management and Economics, Shahid Bahonar University of Kerman, Kerman, Iran.

2 Associate Professor of Economics, Department of Economics, Faculty of Management and Economics, Shahid Bahonar University of Kerman, Kerman, Iran.

3 Professor of Economics, Department of Economics, Faculty of Management and Economics, Shahid Bahonar University of Kerman, Kerman, Iran.

Abstract

This study is conducted with the primary objective of determining the optimal rate of monetary growth and identifying the preferences of monetary policymakers within a backward-looking expectations framework. To achieve this aim, the loss function of the central bank was formulated by incorporating structural constraints, including aggregate supply and demand equations. The parameters of this function were estimated using the Vector Autoregression (VAR) method, based on data covering the period from 1978 to 2022. The empirical results indicate that the preferences of monetary policymakers are structured in such a way that the central bank’s loss function is minimized. Specifically, the dominant weight is assigned to controlling liquidity (λm = 0.95), followed by the containment of inflation. This finding suggests that fluctuations in inflation in the Iranian economy are largely driven by changes in the money supply, and that effective liquidity management plays a pivotal role in reducing welfare losses and enhancing macroeconomic stability. In addition to the historical analysis, the study extends its scope to forecasting future trends in monetary growth. Using Monte Carlo simulation techniques, the growth rate of liquidity was projected for the period 2023 to 2061. The simulation results reveal that the liquidity growth rate is expected to remain close to 26 percent over the long run. If realized, such a trajectory would likely generate persistent inflationary pressures and pose significant challenges for the efficient allocation of resources. These outcomes underscore the critical importance of revisiting current monetary policies and adopting innovative strategies aimed at moderating liquidity expansion. By doing so, policymakers can mitigate inflationary risks, improve resource distribution, and strengthen the overall effectiveness of the monetary system.

Keywords

References

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