Monetary policy refers to the economic strategy which the government chooses when deciding how the countrys money supply will increase or decrease. This is usually done through the nations central bank. This paper looks at the monetary policy as set up in turkey for the management of fiscal policies in the country.
Three major tools are used to implement monetary policy. These are change of credit restrictions, buying and selling of the national debt and change of interest rates by changing reserve requirements. Monetary policy is relevant because it controls aggregate demand as well as inflation in an economy. Monetary policy can influence inflation in two ways, namely; exchange rates and interest rates. When interest rates or exchange rates rise, the economy is forced to slow down and thus the inflationary pressure is reduced. When interest rates and exchange rates decline as well, the economy is stimulated leading to an increased inflationary pressure.
Turkey is in Europe and it is a Latin American country. Turkeys economy has not been the same since its crisis in 2001. To clearly explain the Turkish monetary policy and the changes it has been through, I will go back in Turkeys economic history and go through the details of its monetary policy.
In 24th January, 1980, new measures were taken by the Turkish economy. These measures facilitated an economy which was based on the forces of a free market. Financial liberalization was slowly realized henceforth. Later on in 1990, the Central Bank of Turkey (CBRT) made official a monetary program in a medium term horizon. This monetary program made it possible for the CBRT to manage credits extended to the public sector. In effect, the share of the of Turkish lira liabilities increased in the balance sheet. There was a decline in cash credit to public sector as well as the CBRTs net foreign liability. While there was increase to the credits to banking sector in real terms, there was decline to the cash credit of public sector in nominal terms. Eventually, the cash credits to the banking and public sectors declined in real terms as opposed to changing in nominal terms in1990. As much as the account of revaluation had not changed as previously proposed, control on CBRT credits facilitated the stay in total domestic assets target interval. Even though the share of the CBRT reserve increased, it was hardly felt because its assets were financed by bringing about foreign liabilities (Emir, 2000).
In 1992 to 1993, the economy had a recovery as a result of increase of real wages in the public and private sector, import growth and deteriorating fiscal balances. A monetary program was in effect created relying on assumptions which were inflation related, the borrowing of the public sector from the CBRT and consolidated budget deficit. The credit which was extended to the public sector was increasingly expanding and it thus hindered the CBRT from complying with the monetary program targets. The CBRT opted to instead do away with excessive fluctuations in exchange rates. In the end of 1993, the government strived to reduce the cost of domestic borrowing and thus borrowed very small amounts or nothing at all even though the fiscal deficit was increasing. As treasury depended on CBRT, excess liquidity was created and thus widened the gap between the official exchange rate and that of the market. A crisis was created which consequently lowered the economy and drastically increased the interest rates of securities belonging to the government.
The monetary policy of the CBRT was later on heavily controlled by the financial crisis in 1994. The devastating consequences were felt on fiscal balances because of decreased foreign borrowing which forced the Treasury to opt for domestic borrowing in financing the budget deficit. This put unbearable pressure on the financial system. The period between 1996-1997 saw the CBRT centering the implementation if its monetary policy on ensuring that financial markets achieve stability. The CBRT influenced the increase of domestic assets and domestic liabilities in return for the increase in foreign assets. The exchange rate policy made certain that export sector was competitive, presence of effective exchange rate stability and a current account deficit which was sustainable. The CBRTs official reserve hit 21 billion US dollars thus ensuring that it could cushion itself against other attacks (Emir, 2000).
In 2000, the CBRT shifted to an exchange rate policy which was based on future inflation targets therefore introducing a new monetary policy framework. Initially, the program bore fruits since exchange rates decreased drastically but then commercial banks raised up their assets denominated by Turkish Lira with longer maturities presented by government securities and consumer credits. The open positions of foreign exchange were also increased thus exposing the banking system to all manner of potential shocks. The Turkish Lira appreciated in real terms because of increased demand and increased oil prices. This in turn made the inflation to increase. A transitional program was put in place between 2001 and 2002. Then Turkey started to follow a new IMF supported program.
In 2001 the Central Bank Law was amended. This provision made it possible for the bank to take necessary steps in ensuring financial stability and price stability. A new policy was thus launched by the end of 2010. To deal effectively with financial imbalances, reserve requirement ratios and interest rate corridor policies are employed. In effect, these policies hamper excessive deviation of exchange rates, excessive credit growth and sensible growth of the economy in a stepwise way. This introduced monetary policy was defined in two ways. First, the hampering of the Turkish Lira from over-appreciating as well as projecting capital inflows to long term investments. Second, rebalancing domestic and external demand as well as ensuring control of growth in domestic loans and demand.
At this time, the corridors rates of interest were pulled southwardly and to discourage short term carry trade; the overnight rates of interest would be allowed to fall below the rate of policy from time to time. To hamper extravagant credit growth and influence domestic demand; reserve requirement ratios were raised up. In 2011, the interest rate corridor was made slimmer and overnight rates of interest would be allowed to rise above the policy rate. Liquidity measures were put in place to restrict fluctuations in the foreign exchange market and the Turkish lira reserve requirements were reviewed so as to decrease the bankings sector liquidity requirement. All these ensured that the level of fluctuations of exchange rates reduced and imparted to moderation of excessive credit growth (Basci, 2012).
As from February, 2012, the interest rate corridor was lowered as a result of reduced risk which threatened of a stop to capital inflows. Short term interest rates were in effect maintained relatively flat. Monetary tightening was put in place as well to contain risks brought about by pricing levels. All these policies have helped in prevention of possible inflation. In recent years the Monetary Condition Index (MCI) has been the monetary policys operational target. The MCI comes about when short term interest rate and the exchange rate are combined. With this change comes increased interest in quantification of the effects caused by policy instruments on inflation, output as well as use of these estimates in the monetary policys conduct.
The MCI can be constructed in two ways. One can choose to be attentive on effects caused by changes in interest and exchange rates on prices. Here, the exchange rate is more relevant because it directly affects prices and indirectly affects aggregate demand. The other option focuses on obtaining the weights employed on MCI by making an estimate of the aggregate demand equation. The results of the estimation will demonstrate how changes in in interest and exchange rates affect aggregate demand. The MCI for Turkey is constructed by obtaining the weights through estimating the price equation, the reason being that the exchange rate is assumed to be the force that drives the process of price adjustment. The weights present in the MCI reflect on the inflation as well.
Since 2010, the exchange rate has mostly moved towards the path intended by the CBRT. When the new policy was implemented, the Turkish Lira moved away from the emerging market economies. While most emerging market currencies drastically depreciated against the US dollar during the global risk appetite, the Turkish lira showed limited depreciation. This is a clear indication that the policies that have been put in place by the CBRT have tremendously assisted in safeguarding the economy. Exchange rate volatility have been lower than other emerging economies since the adoption of the new policy. Despite depreciation of the Turkish lira, its volatility has been stopped. Credit growth has also been moving to sound levels since the adoption of the new policy. In the last quarter of 2010, the momentum of growth was at 50 percent. However, this level has stepwise declined to 15 percent. The CBRT has thus been effective in controlling credit growth.
To encourage the use of the new policy, the CBRT emphasized on the relevance of controlling the cyclical component of the current account deficit as well as changing growth composition to net exports. This is also referred to as rebalancing and soft landing. Since mid-2011, the current account deficit had started to decrease. By the end of the year 2011, movement of portfolios and short term capital inflows was the main mode of financing. Direct foreign investments and long term borrowing made up the composition of external financing. Imports decreased in real terms as exports held on to an upward trend. This ensured that there was a higher contribution of net exports to growth and gives evidence to rebalancing. Consumption and investment had a flat trend since the beginning of 2011 as GDP continued to increase. This is evidence that the policies put in place were successful.
All the above factors show that the CBRT has used an effective policy framework. In order to control bank loan growth, it used reserve requirements. To increase return ratio and hinder overnight currency flows it used volatility of the overnight rate. For back door policy tightening it granted permission for interbank rate to be above the policy rate systematically. Banks were also permitted to have foreign currency in reserves to realize a secondary exchange rate which the CBRT controlled in order to make a calculation of the amount in reserves, hoping that this would affect the market exchange rate (Gurkaynak, 2015).
Clearly, to achieve improved monetary policies, there must be structural reforms. The institutional framework to safeguard financial stability started in 2011. The CBRT was forced to come up with this framework after the global crisis. The need to change the landscape of central banking and increase of capital flow volatility in the wake of extraordinary global conditions led to this realization. This paper clearly shows that the monetary policy adopted by the CBT averted the extreme effects which were caused by capital flow volatility. The policy has also led to rebalancing and ensuring a soft landing of the economy. The decrease of current accounts deficit without going through a crisis shows that other economies can learn how to modify existing inflation which targets frameworks and thus make more room for financial stability.
Nas, T.F and Perry, M.J, 2000. Inflation, inflation uncertainty, and monetary policy in Turkey: 1960-1998. Contemporary Economic Policy 18(2), pp.170-180
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