Taylor Rule in Turkey

Has the Turkey’s monetary policy been sufficiently tight? This question becomes extremely crucial especially after the Turkish politicians’ blistering attack on the central bank that have raised the concerns about the independence of Turkish central bank. Amid these concerns Turkey central bank has cut the rates twice in 2015 bringing its policy rate from 8.75% down to 7.50%.

Taking back to the question asked at the prelude, the Taylor-rule framework can be used to assess the appropriateness of the monetary policy stance of Turkish Central Bank. Therefore we would be able to evaluate how the central bank responses to inflation and output gap. We can also judge the actual rates by using Taylor rules as a benchmark rate. Despite the fact that these exercises are near impossible to do given frequent structural breaks in the way monetary policy has been conducted resulting in the absence of consensus of what the appropriate coefficients would be for a Taylor rule in Turkey, I’d like to keep on with the most commonly known Taylor rule which implies a response of 0.5 both inflation and output gaps and a real interest rate target of 2%.

I also intend to widen the scope of the work by projecting the Taylor rule to the end of 2016 with using the country-specific economic forecast of OECD as an input who estimates Turkish economy to grow by 3.0%, 3.2%, and 4.0% in 2014. 2015 and 2016, respectively, and the headline inflation rates to be standing at 9%, 7.4%, and 6%.

Turkey - Inflation and Output Gaps

Turkey - Taylor Rule vs Actual Interest Rates

The first above shows the estimated inflation and output gaps in Turkey while the latter generates some important results for my Taylor-rule based assessment of Turkish monetary policy. Turkish monetary authority appears to be remain eased following the global financial crisis. Thus, our question becomes answered. Additionally, within the macroeconomic prospects Turkey may not have to deliver massive rate hikes as a response to the United Federal Reserve’s tightening. However, inflation shocks arising out of fast local currency depreciation and rising food prices and volatility in money markets remain as a key risks to this assumption.

On the Failure of Inflation Targeting

Right after the shocking rate hike by Turkish Central Bank and the elections that is thought to have removed the political risk, we began to see Turkish lira not under pressure anymore, unlike the central bank.

Firstly, let us remember the deep thoughts Turkey’s Finance Minister on the economy,

  • SIMSEK SAYS TURKEY ‘WON’T WASTE THIS CRISIS’
  • WE’LL TURN THIS CRISIS INTO AN OPPORTUNITY,’ SIMSEK SAYS

On capital outflows,

  • SIMSEK: TURKEY SAW INFLOWS, NOT OUTFLOWS IN LATEST PERIOD
  • SIMSEK: I BELIEVE WE WON’T SEE OUTFLOWS THIS YEAR
  • SIMSEK: BUT WE ALSO HAVE TO ATTRACT CAPITAL

and next he says,

  • SIMSEK SAYS ERDOGAN IS MISUNDERSTOOD ON INTEREST RATES LOBBY
  • SIMSEK SAYS TURKEY’S INTEREST LOBBY TALK NOT ANTI-INVESTOR
  • SIMSEK SAYS TURKEY GOVT PLANNING MEASURES ON CORRUPTION

It is hard to make sure that the nation on the Boshporus has no idea what is doing while a man in such a high place needs a Introduction to Economics book in order to eliminate his nonsense  theories.

Things are not getting normal when we take a look at monetary policy.  Until the midnight express, we had seen the rates engineered by the central bank as the policy rate had lost its function. With the currency bouncing back, it did not mean no offense or pressure on the central bank but the government clearly showed its intolerance with high rates. Not surprisingly, this time the rates engineered by the central bank are under its policy rate. The funny thing is that the central bank stated that it would sustain it tight monetary policy stance until a significant improvement in the inflation outlook. Things are getting even more abnormal when we compare both headline inflation and core inflation to the target of the Turkish Central Bank.

Turkey - Inflation Chart

Like I said it is hard to make sure.

P.S: Targeted inflation rate in Turkey has been 5% for the last three consecutive years.