Monetary Policy Responses to Foreign Financial Market Shocks: Application of a Modified Open-Economy Taylor Rule

With world economies facing increasing financial liberalization and financial crisis, the question raised is whether and how monetary authorities in various economies have responded to foreign financial shocks? In this paper, the focus of the question is directed at Iran, which will be examined through a modified open-economy Taylor Rule that considers foreign financial shocks from Saudi Arabia and Kuwait, representing the Middle East, and the U.S., Germany, and Japan, representing the rest of the world. Results suggest that although Iran’s monetary policy does not fit the Taylor Rule, it has responded to some foreign financial level and volatility shocks over the period of study, 1997-2013. Findings in this paper, following earlier findings in Ezzati (2013a) and (2013b), indicate that Iran’s monetary policy has not been completely based on economic changes and macroeconomic influences, but has been based more on controversial political concerns.