Role of Pre-Event and Post-Event Indicators in Assessing the Impact of Monetary and Fiscal Shocks on Financial Instability in Iran

The objective of this study is to examine the role of the type of financial instability indicator in the assessment of monetary and fiscal policies in Iran, with this assessment being conducted through a comparison of pre-event and post-event indicators. To this end, a Bayesian New Keynesian Dynamic Stochastic General Equilibrium (DSGE) model, together with pre-event and post-event indicators, is employed for the period from 1989 to 2022. Five types of spreads involving the interest rate, lending rate, return on entrepreneurs’ capital, and bank portfolio returns are used as pre-event indicators, while a post-event indicator is employed as a measure of financial stability. The results show that increases in the spreads between “bank portfolio returns and the interest rate” and “the lending rate and the interest rate,” as well as negative values of the spreads between “the return on entrepreneurs’ capital and the lending rate” and “the return on entrepreneurs’ capital and the interest rate,” lead to an increase in financial instability. The correlation matrix confirms convergence between the pre-event and post-event indicators. The results indicate that, in the case of a monetary shock, the spread between “the lending rate and the interest rate,” and in the case of a fiscal shock, the spread between “the return on entrepreneurs’ capital and bank portfolio returns,” is a more appropriate indicator for assessing financial stability. Furthermore, the spread between “the return on entrepreneurs’ capital and the lending rate” exhibits a stronger response to the shocks. The results show that the response of financial stability indicators to monetary policy shocks is stronger than their response to fiscal policy shocks. The findings emphasize the importance of maintaining a balance between the profitability of the banking sector and that of the real sector of the economy in reducing financial instability. Therefore, monetary and fiscal policies should be designed in a manner that supports the balanced development of these two sectors.