Following a monetary growth rate rule, the present paper ranks four simple monetary rules under various stochastic shocks. The criteria to choose among rules are obtained using a welfare criterion derived from the utility function of the representative agent. The main results are: the effects of alternative monetary rules depend on what shocks affect the economy, exchange rate regime and the inflation index being targeted; with regard to the monetary rules, managed exchange rate rule dominates the other rules under demand or supply shocks, whereas domestic inflation targeting is the best performer under real shocks. As far as the definition of inflation targeting index is concerned, CPI inflation targeting appears to outperform the domestic inflation targeting under demand or supply shocks.

In contrast to the interest rate rule that has prevailed internationally since the 1990s, the current approach to monetary policy formulation in Iran gives the government a decisive influence in setting specific monetary targets. In particular, Five-Year Development Plans (FYDPs) set annual targets for monetary growth and inflation, which are approved by parliament and must be used as a benchmark for formulating monetary programs by the central bank. When looking at the ability to meet inflation and monetary targets set in the FYDPs, the performance of monetary policy in Iran has been less than satisfactory.

The questions that arise here are: What would be the best monetary policy in this conditions? And how does the Central Bank of the Islamic Republic of Iran (CBI) choose among alternative monetary policies? In this paper, we analyze these questions for an open economy of Iran following a monetary growth rate rule in which monetary base growth rate is determined according to output and inflation deviations from their target values.1 We derive a welfare-based loss function for this economy, compute the optimal monetary policy plan, and welfare-rank the performance of alternative monetary policy rules under various shocks using a micro-based DSGE model. A large number of new Keynesian models developed a framework to analyze the properties of alternative monetary policy regimes in case of open economy. Many significant contributions to the literature in that field have been made by Svensson (2000), McCallum and Nelson (2000), Clarida et al. (2001), Corsetti and Pesenti (2001, 2005), Benigno and Benigno (2003), and Gali and Monacelli (2002 and 2005), among others. While there is a large volume of literature on optimal monetary policy in Industrial, Latin American and Asian economies, few of these studies are based on Iran. In Iran, following the pioneering work of Khalili et al. (2009) in this area, other attempts were made by Dargahi and Sharbatoghli (2011), Bahrami and Ghoreishi (2011) and Shahmoradi and Sarem (2013).

Applied Economics Journal, Five-Year Development Plans (FYDPs), Islamic Republic of Iran (CBI), Monetary Policy Rules (MPRs), CIMR, DIMR, MR, MER, Optimal Monetary Policy Rules, Iran, Welfare Analysis.