Prohibition of interest rate in Islamic economic framework has posed a number of problematic challenges in macro model building and execution of monetary policy mechanisms that have not been fully analyzed in the literature. Using a Bayesian methodology, this paper makes a first attempt to develop and estimate a New Keynesian small open economy DSGE Model for Iran which is among the pioneering countries whose banking operations comply with the sharia. The central banks in an Islamic framework should develop innovative types of shariah-compliant financial instruments that are also complying with conventional economics. Since there is not actual data available on interest rate and enough data on other possible monetary instruments in Iran, we introduced the nominal exchange rate as an alternative monetary policy instrument for Iranian economy.

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