Investigation of dynamic relationship between monetary and fiscal policies in Iran

One of the main goals of the economy of each country is to achieve an appropriate economic growth and Prices stability. To achieve these goals, governments employ two important tools, financial and monetary policies. A financial policy in which the level of government tax and spending is determined, and a monetary policy that mainly deals with managing money supply and adjusting interest rates. The financial policy is used by the government of each country while the monetary policy is used by the central bank. In resently years, debates over the relationship between financial and monetary policies have become more important in the economic literature. One of the important goals of fiscal policy makers is to keep the state budget balanced. In the event of a budget deficit, the government may borrow from the central bank or withdraw its deposits in central bank, which means money creation and financial dominance. that can cause inflation. In this situation, if the government can finance the internal deficit and the temporary budget deficit without changing the policy or at the level of prices, then a stable financial policy has been used (Kuncoro et al., 2013, p. 53). On the other hand, the implementation of monetary policy to control of inflation, will increase the rate of interest, and then the future budget deficit will increase due to the financial obligations of the government, which could lead to more money and higher inflation (Baieng and et al., 2006, p. 56). Sargent and Wallace (1981), showed that monetary policy, without coordinating with fiscal policies, could not maintain price stability in the short and in the long run. َ Actually, the macroeconomic goals, such as maintaining the stability of prices and growth of production depend on the proper and accurate monetary and financial policies and the coordination of these policies. In this research, we study the response of monetary policy makers to financial policies, as well as the response of financial policy makers to monetary policies, emphasizing the goal of economic stability, in Iran. The ratio of the amount of liquidity to GDP and the ratio of budget deficit to GDP respectively are considered as criteria of monetary policy and financial policies.  we have tried using 1978-2013 time series data and econometric method of auto distributed lag (ARDL) and examines the dynamic relationship between fiscal and monetary policies in the face of changes in macroeconomic variables economy. The results show that the reaction of monetary policy in the face of increasing the ratio of budget deficit to GDP, appears to increase the ratio of liquidity to GDP. Also in the face of increasing the ratio of liquidity to GDP, the fiscal policy makers decrease the ratio of budget deficit to GDP. These results indicate the dominance of fiscal policy on the economy of Iran. Comparing coefficients of the variables of liquidity in financial policy reaction function and budget deficit in monetary policy reaction function shows that sensitivity of monetary policymakers in the face of fiscal policy is more than sensitivity of fiscal policymakers in the face of monetary policy. Therefore, following the increase in budget deficit, which is an instability factor in macroeconomics, the reaction of central bank, may increase inflation and therefore further instability. Other results show positive and significant relationship between oil price, interest rate, government debt to central bank, output gap and RM, inflation, exchange rate and RPB. Also the results show negative and significant relationship between inflation, exchange rate and RM and interest rate, oil price and RPB. Relationship between RPB and theoutput gap is not significant.