Recent studies find empirical support for the role of monetary policy rules, such as Taylor rules, in exchange rate determination.

The short term interest rate in Iran is not determined by any rulebased monetary policy that may affect the exchange rate (Rial- Dollar) and its fluctuations. This paper introduces the Taylor rule as a new strategy to Iran’s monetary policy. Indeed, this is the first attempt to deal with a rulebased monetary policy strategy in Iran’s economic performance. Hence, we estimate the short term interest rate with respect to Taylor rule and calculate the difference of actual short interest rate and the fitted interest rate as a Taylor rule deviations. The latter is considered a relationship between the real interest rate and the exchange rate in Taylor rule exchange rate model. In this step, we consider two specifications. In the baseline specification only the macro fundamentals (inflation gap, GNP gap, ...) are considered, whereas in the second specification Taylor rule deviations are included as well.

JEL classification: F31, E5, F41

Keywords:  Monetary policy, Interest rate, Exchange Rate, Taylor Rule.