Causal Relationship Between Exchange Rate and Monetary Base in Iran’s Economy: New Evidence from the Wavelet-Based Cross-Regression and Local Multiple Cross-Correlation Model

Document Type : Research Paper

Author

Assistant Professor,Economics, Department of economics and administrative science, University of Qom, Qom, Iran

Abstract

In today’s world, exchange rate fluctuations and monetary policies are recognized as two key drivers in the dynamics of national economies. For Iran’s economy, which is heavily dependent on oil revenues and significantly affected by economic sanctions, the importance of these two variables is even greater. In this regard, analyzing the relationship between the monetary base and the exchange rate in Iran can have a considerable impact on economic policymaking and effective decision-making. This paper examines the causal relationship between the monetary base and the exchange rate in Iran’s economy using the wavelet-based cross-regression and correlation model (WL-WCRC) and monthly data from April 2001 to August 2024. These two variables play a fundamental role in influencing inflation, economic growth, purchasing power, and financial stability. The findings of this study indicate that the impact of the monetary base on the exchange rate, and vice versa, varies significantly across different time scales. Since 2012, following intensified exchange rate volatility and economic shocks, the exchange rate's influence on the monetary base has become stronger. During this period, although short-term correlations weakened—sometimes approaching zero—a significant and reciprocal long-term relationship between the two variables persisted. Moreover, market expectations and speculative behaviors have played an essential role in amplifying exchange rate volatility. The results further show that since 2012, the Central Bank’s monetary policies have been largely reactive to exchange rate fluctuations. From 2001 to 2012, the monetary base acted as a key determinant of the exchange rate. In later years, particularly amid rising exchange rate volatility and currency crises, the exchange rate exerted a more substantial influence on the monetary base. These findings highlight the complexity of the relationship between the monetary base and the exchange rate in Iran’s economy, demonstrating that managing exchange rate volatility requires proactive monetary strategies independent of currency shocks. Overall, the study emphasizes that the relationship between the monetary base and the exchange rate in Iran is both complex and time-dependent, with evidence of a bidirectional long-term correlation. These insights can assist policymakers in designing more effective monetary and exchange rate policies to control currency fluctuations and their economic consequences better

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References

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