Test of Exchange Rate Determination Models

Trade in goods and services between countries, capital flows as well as many macroeconomic variables are of great importance in determining the exchange rates traded in national and international markets. It is seen that the amount of money in national and international markets, interest rates determined by central banks, growth and inflation rates affect exchange rates. There are many models developed in the literature regarding the determination of the exchange rate. The aim of the study is to investigate which of the developed models related to the determination of the exchange rate is valid for Türkiye. In the study, purchasing power parity model for Jan. 2003–Oct. 2021 period, Mundell–Flemming model for Jan. 2006–Sept. 2021 period, monetary model with flexible-price assumption for Sept. 2005–May 2021 period, and monetary hybrid model Jan. 2006–May 2021 period was analyzed for the period of Jan. 2006–May 2021. Fourier ARDL and ARDL cointegration tests were used in the analysis of the data.

As a result of the analysis, it was found that real variables did not affect the exchange rate much, the activity was mostly due to the financial system, and the change in the money supply and the interest rate affected the exchange rate. It is seen that exchange rates are affected by the exchange rate values of the past period. It has been concluded that monetarist approaches are more explanatory in explaining exchange rate changes, and even that the monetarist hybrid model has the highest explanatory power for Türkiye. As a result of the study, it was found that the exchange rate is sticky. From this point of view, it can be suggested to observe transparency during the determination and execution of exchange rate policies and to increase confidence in the Central Bank.

Keywords: Exchange Rate, PPP, Monetary Theory, ARDL, Fourier ARDL

Today, exchange rates have become the center of attention for all segments of the economy, from commodity markets to financial markets, from public and private sector investments to individuals, and have become one of the main determinants of macroeconomic balance. The exchange rate, which is defined as the value of one country’s currency against another country’s currency, has become an increasingly important factor for every country engaged in economic activities with the outside world. In addition to trade in goods and services, the impact of foreign exchange transactions is increasing day by day due to their use in banking and derivative market transactions and domestic and foreign investment decisions. Due to the globalizing world economy, currencies with high convertibility such as U.S. Dollar, Euro, Sterling and Japanese Yen are more preferred due to the transaction volume in foreign currency transactions. Increasing transaction volumes increase the importance of monetary policies and exchange rate policies implemented by countries. Today, with globalization, exchange rates are affected not only by domestic dynamics but also by developments and dynamics outside the country.

There are many macroeconomic indicators that affect exchange rates. Indicators such as money supply, inflation rate, short- and long-term interest rates, GDP are among the leading dynamics affecting exchange rates. Favorable or unfavorable economic developments inside or outside the country may lead to improvement or deterioration of these indicators over time. Countries try to take measures against possible economic shocks with monetary and fiscal policies. The fact that the majority of economies have become open to foreign markets with globalization has further increased the importance of exchange rates. In this context, exchange rate stability and exchange rate determination models have become increasingly important.