The role of exchange rate in inflation targeting: the case of Turkey

ABSTRACT

The role of the exchange rates in emerging market economies that have adopted inflation targeting (IT) is a critical and contentious issue in the relevant literature. This article investigates whether an exchange rate-augmented Taylor rule describes the Central Bank of Republic of Turkey’s (CBRT) monetary policy. Covering the period from 2002:1 to 2017:8 it also explores possible nonlinearities in the reaction function of the CBRT by employing a Threshold Vector Autoregressive (TVAR) model. The linear estimation of the model highlighted the importance of the exchange rate in monetary policy under IT. The results of the nonlinear model indicate that the stance of monetary policy was asymmetric with respect to exchange rate movements during the conventional IT period. However, the asymmetric monetary policy stance disappeared in the aftermath of the Global Financial Crisis. Increasing considerations of financial stability undermined the asymmetric policy stance of the CBRT in the post-crisis period.