Taylor Rule in Turkey
- March 27, 2015
- Self Made Trillionaire
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%.
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.