Theory and Applied Macroeconomics

1 Introduction

Monetary policy can be defined as the change of money supply by the central bank using various monetary policy tools in order to achieve its ultimate goal. In Türkiye, the Central Bank of the Republic of Turkey (CBRT) is responsible for implementing monetary policy. Türkiye experienced high and volatile inflation rates starting from the 1980s until the implementation of implicit inflation targeting regime in 2002. During this period, different monetary policies are implemented depending on the economic and financial conditions in the Turkish economy. Regarding monetary policy implementation, 1986 was a turning point. Before 1986, since the financing of the public sector budget deficit was provided by the CBRT financial resources, monetary and fiscal policies were carried out interdependently. In 1986, a significant change was made in the implementation of monetary policy. Starting from this year, there was a tendency to control total reserves of the banking sector in order to control the money supply and increase effectiveness of interest rate policy.

In 2002, the CBRT started to implement “implicit inflation targeting” monetary policy regime. The main objective of the implicit inflation targeting regime was to ensure price stability. The CBRT started to implement “inflation targeting regime” at the beginning of 2006. The inflation target is disclosed to the public at three-year periods in order to be in line with the three-year budget plans that have been implemented since 2006.

In this study, a general evaluation of the monetary policies implemented in Türkiye around past 37 years between 1986 and 2023 is done. When doing this evaluation, three important pre-requisites for an effective implementation of monetary policy should be kept in mind: 1- The implementation of fiscal policy and debt finance in an predictable way, 2- Political stability and 3- Efficiently working banking system.

In this framework, following questions are tried to be answered: What were the objectives of the monetary policies during this period? Which monetary policies were implemented? How did the inflation rates evolve? Were the monetary policies successful in reducing inflation? Which monetary policies were successful to support economic growth?

2 Monetary Policy and Central Banking

Monetary policy can be defined as the change of the money supply by the monetary authority, i.e., central bank, using various policy tools in order to achieve its ultimate goal regarding economic or financial variables. Theoretically, the ultimate goal of monetary policy can be one or more of the following: price stability, financial stability, economic growth, full employment, exchange rate stability and interest rate stability. The ultimate goal of the monetary policy has been changed overtime within the framework of changing economic conditions. For example, before the 1970s, the goal of monetary policy was full employment and economic growth. In the 1970s, oil prices increased due to oil crises and then, high inflation has emerged in many countries. As a result, central banks implemented expansionary monetary policies in order to eliminate the negative effects of oil price increases in their economy. Therefore, the goal of monetary policy was shaped as controlling inflation and ensuring monetary stability. Today, the primary objectives of monetary policy implementations are price stability and financial stability.

Price stability is defined by the former Federal Reserve Board (FED) Chairman Alan Greenspan as “ Price stability is best thought of as an environment in which inflation is so low and stable over time that it does not materially enter into the decisions of households and firms.” (Greenspan, 2002: 6). As can be understood from this definition, in order to ensure price stability, the inflation rate must be low and the low inflation rate must be maintained over time. No numerical value is given for the inflation rate. Financial stability is defined as the efficient working of financial system and transfer of funds from savers to investors without interruption. The central banks are institutions that are authorized to issue banknotes and to implement monetary policies of countries. Central banks provide loans or accept deposits to banks as the “ultimate lending authority” or “last lending authority”. For this reason, central banks are also described as “banks of banks”. Historically, central banks were established as private commercial banks rather than as non-profit public institutions (Capie, Goodhart & Schnadt, 1994: 4–5). The first truly central bank in the world was the Bank of England, founded in 1694. The Bank of England had the three functions that a central bank should have: the power to issue banknotes, being the bank of the state, and being the lender of last resort.

The main reason why countries want to have their own central bank is that they can keep control of issuing money under a single authority. Every independent country wants to have a national currency and central bank as a sign of its independence. Loss of control over money issuance means increased inflation. For example, after the Napoleonic wars, excessive printing of money to cover war expenses caused high inflation, so the idea of giving money printing to an independent organization arose. The second important reason is that central banks obtain seigniorage revenue by printing banknotes.

3 History of Central Banking in Türkiye and the CBRT

The historical development of central banking dates back to the Ottoman Empire (Tekeli and İlkin, 1997). The bank that carried out the first central banking activities during the Ottoman Empire was “Bank-ı Osmani Şahane” which was established in 1863 for the purpose of paying foreign debts between the Ottoman Empire and European countries and providing foreign financing. Bank-ı Osmani Şahane, founded as a British and French partnership, undertook some of the modern central banking functions such as the state treasurer collected the state’s revenues and made payments, discounted treasury bills and made principal and interest payments of domestic and foreign debts. The privilege to print banknotes was given to this bank for 30 years. After the establishment of the Republic of Türkiye, the idea of establishing a national central bank was first brought to the agenda at the Turkish Economic Congress held in 1923. Although some attempts were made to transform Bank-ı Osmani Şahane into a state bank, this could not be realized due to unsuitable economic and financial conditions. The works about establishing a national central bank started again in 1927.

The Central Bank of the Republic of Turkey (CBRT), which is responsible for the implementation of monetary policy in Turkey and has the sole authority to issue banknotes, was established as a joint stock company with private law legal personality on June 11, 1930 by Law No. 1715 and started its activities in 1931 (Bakır, 2007). As can be understood from this definition, the CBRT is not a public institution. CBRT is a joint stock company established by its own special law, and in cases where there is no clarity in the founding law, private law provisions will be implemented. The founding capital of the CBRT is 15 million Turkish Lira. The authority to issue banknotes was granted for a period of 30 years, and it was stipulated that this period could be extended five years before its end.

When the CBRT was established, its main purpose was to support economic development. In this respect, it would determine the rediscount rates, regulate the money market and the circulation of money, carry out treasury transactions and take all measures jointly with the government to protect the value of the Turkish Lira. The CBRT Law has been amended many times in order to adapt to changing economic conditions over time. Most of the changes made were to increase the loans given to the Undersecretariat of Treasury and State Economic Enterprises. Thus, the main function of the CBRT has been to finance the public sector deficits rather than carrying out an effective monetary policy.

With the beginning of the planning period in the 1960s, the idea that the existing CBRT Law was not sufficient to carry out the monetary policies necessary for economic development gained importance. In order to meet the changing economic and financial needs, Law No. 1715 was repealed and Law No. 1211 came into force on January 14, 1970. In the new CBRT Law, the main duties of the CBRT are stated as carrying out the monetary and credit policy, taking measures to protect the value of money, and carrying out the printing and lending of money. Amendments were made to Law No. 1211 from time to time. The CBRT Law currently in force is Law No. 1211, amended by Law No. 4651 and dated 25 April 2001.

4 Monetary Policies Implemented Between 1986 and 2001

Türkiye experienced high and volatile inflation rates during the 1980s and 1990s (Figure 1). The main reasons for high and volatile inflation rates were financing high budget deficits by the CBRT funds followed by pricing policies implemented to finance public sector deficits, political instability in the economy and increases in oil prices in the world. High budget deficits prevented implementation of monetary policy and other policies in an effective way as well as structural reforms could not be realized.

Therefore, the authorities tried to maintain and manage current economic situation without causing bigger problems. The vulnerabilities have increased in the economy and an environment has been created for possible negative developments to create large jumps in inflation. During this period, economic growth rate was also not stable, it had up and downs and had negative values during the crisis years such as 1980, 1994, 1999, 2001, 2008 (Figure 2).

1986 was a turning point in monetary policy implementation. Before 1986, since the financing of the public sector was done with the resources of the CBRT, monetary and fiscal policies were carried out interdependently. Since 1986, there has been a tendency to control total reserves of the banking system in order to control the money supply and increase the effectiveness of interest rate policy. In this context, in 1987 and 1988, monetary policies were implemented by the CBRT in a way to carry out these policies. In 1989, taking into account the impact of the size of the Central Bank’s balance sheet on monetary developments, monetary policy was implemented to control this size. During this period, domestic credit expansion was stopped and balance sheet growth resulted only from the increase in foreign assets and the change in the valuation account.

In 1990, monetary policy was announced to the public in detail for the first time. The CBRT wanted to control its balance sheet size by placing limits on the total balance sheet size, total domestic liabilities, total foreign assets and central bank money. In 1991, due to impact of the Gulf Crisis, monetary program was not announced and as a result of the rapid increase in public deficits, the targeted monetary aggregates were significantly exceeded.

In 1992, the monetary program was announced, but since the announced targets were largely exceeded as a result of the rapid increase in public deficits, monetary policy was shaped to prevent excessive fluctuations in the exchange rates. In 1993, the announcement of the monetary program was abandoned and it was declared that monetary policy would focus on maintaining stability in financial markets. After the decisions of April 5, 1994, monetary policy was directed towards ensuring stability in financial markets and increasing foreign exchange reserves.

In 1995, a stand-by agreement was signed with the IMF and targets were set for Net Domestic Assets (NDA) and Net International Reserves (NIR) in the CBRT balance sheet. Exchange rate policy as in the previous periods, was used as a nominal anchor in the fight against inflation and an exchange rate increase at or below the inflation rate was envisaged. The stand-by agreement was ended after the general elections held in December of 1995.

In 1996, due to increasing uncertainties in the economy, stability in financial markets was maintained instead of fighting against inflation. Exchange rates were kept under surveillance and balance sheet size of the CBRT was tried to be kept under control.

In 1997, monetary policy continued its implementation in 1996. While attempts were made to ensure the stability of financial markets, exchange rates continued to be used as an intermediate target in the fight against inflation.

In 1998, while stability in financial markets continued to be maintained, the fight against inflation was included among the objectives of monetary policy. In this context, a monetary program targeting the reserve money size in quarterly and six-month periods was prepared and announced to the public.

In the first months of 1999, monetary policy operated as a continuation of the monetary policy of 1998. In December 1999, a stand-by agreement was signed with the IMF and within this framework, the “Exchange Rate Based Inflation Reduction Program” was put into practice. The program in question adopted a tight fiscal policy, increasing the primary surplus, carrying out structural reforms, accelerating privatization and implementing an income policy compatible with the inflation target.

In 2000, the basic element that determined the framework of monetary policy was the “Exchange Rate Based Inflation Reduction Program”. Starting from the beginning of 2000, an inflation reduction program that will cover a three-year period has been implemented. The aims of the inflation reduction program were to reduce Consumer Price Index (CPI) inflation to 25 % at the end of 2000, 12 % at the end of 2001 and 7 % at the end of 2002, to reduce real interest rates to reasonable levels, to increase the growth potential of the economy and to ensure an effective and fair distribution of resources in the economy.

Following the financial crises in December 2000 and February 2001, a new economic program was implemented in May 2001 under the name “Transition to a Strong Economy”. Within the framework of this program, monetary policy would focus on ensuring stability in the financial markets within a period called the transition period, then its main goal would be to ensure price stability. The main difference of the current program from past programs is that monetary policy is implemented under a floating exchange rate regime. During this period, the monetary base was accepted as an intermediate target (nominal anchor). In order to ensure monetary control, upper limits were set for NDA and lower limits for NIR.

In sum, it could be said that although many different monetary policy programs were implemented to reduce inflation rates between 1986 and 2001, they were unsuccessful to reduce high inflation rates (see Figure 1). The major reasons for failure to reduce high inflation rates were financing budget deficits with the CBRT funds, pricing policies implemented to finance public sector deficits, failure to realize structural reforms such as privatization and banking sector reform, implementation of short-term economic programs instead of long-term programs due to frequent elections, political instability, common distrust to policies by the public, dollarization and inertia in the economy due to high inflation (i.e., economic decisions are taken based on past experiences).

5 Implicit Inflation Targeting Regime

In 2002, a stabilization program was launched, aiming to reduce the inflation rate to 12 % over a three-year period, and then to single digits. The main points of implicit inflation targeting regime can be summarized as follows (Pınar and Erdal, 2016: 164–165):

The ultimate goal of monetary policy was to reduce CPI inflation rate to 35 % by the end of 2002. In order to achieve this goal, the monetary base would continue to be used as an intermediate target and the monetary base would be increased by 40 %, which is the nominal GDP increase. The upper limits on NDA would be monitored as an indicator criteria and the lower limits on NIR would be monitored as a performance criteria. The short-term interest rates would be used to reduce inflation. The CBRT could change short-term interest rates by taking into account the values that inflation could take in the future.

Implicit inflation targeting regime was successful in reducing inflation rate from 69 % in 2001 to 29,7 % in 2002, then it decreased to 7.7 % in 2005 (Figure 3).

6 Inflation Targeting Regime

The inflation targeting regime is a monetary policy regime that is widely used in both developed and developing countries. Inflation targeting is carried out as the implementation of monetary policy towards the inflation target in order to ensure and maintain price stability. Inflation targeting firstly implemented in New Zealand in 1990. In the countries where inflation targeting regime is implemented inflation rates and its volatility decreased and economic growth increased. The CBRT started to implement “inflation targeting regime” at the beginning of 2006. The main elements of the inflation targeting regime can be summarized as follows (Pınar ve Erdal, 2016: 167–169):

• – The inflation target is determined jointly with the Government, and monetary policy implementation is at the initiative of the CBRT.
• – The targeted inflation rate is determined as a “point target”, taking into account the advantages of being easily understood by the society and effectiveness in directing expectations.
• – The inflation target is determined as the year-end CPI inflation and is calculated as an annual percentage change.
• – The inflation target is announced to the public every 3 years in order to be compatible with the three-year budget plans that have been implemented since 2006. In this context, year-end inflation targets for 2006, 2007 and 2008 were determined as 5 %, 4 % and 4 %.
• – Within the framework of the CBRT’s accountability mechanism, an “uncertainty range” of ± 2 points above and below the inflation target has been created.
• – Directing expectations is of great importance in inflation targeting regime. The CBRT announces inflation forecasts covering 2 years, creates a path compatible with the target as of the end of each quarter and declares an uncertainty range of ± 2 points around this path.
• – Inflation forecasts show the path that inflation is expected to follow while reaching the final inflation target. For this reason, it would be appropriate for economic units to use inflation forecasts as a reference in the short-term and the inflation target in the medium-term.
• – If inflation remains outside the uncertainty range, the CBRT notifies the Government and announces to the public the reasons for this deviation and the measures to be taken to ensure that inflation reaches the target again, within the framework of Article 42 of the CBRT Law.

In this framework, monetary and exchange rate policies have been successful in reducing inflation rates from two digits to single digits together with the success of measures to reduce government budget deficit and the implementation of structural reforms within the framework of stabilization programs that had been implemented since 2002 (Figure 4). Besides, economic growth rate was higher and stable in the inflation targeting regime (average 5 % between 2002 and 2023) as compared to other monetary policy regimes (average 4 % between 1986 and 2002).

However, there has been an increase in the inflation rates after COVID-19 pandemic starting from 2021. The major reasons for increase in inflation rates can be summarised as follows: the increase of demand due to credit expansion by banks during the COVID-19 pandemic, increases in prices of basic goods groups as a result of increase of import prices due to the depreciation of Turkish lira, increases in the prices of fresh vegetables and fruits, increases in the prices of Services Sector (restaurants and hotels) through food services due to increase in food prices, geopolitical risks due to wars in the neighbor countries and inflation expectations.

7 Conclusion

In this study, the monetary policy implementations by the CBRT to decrease and stabilize the high and volatile inflation rates are evaluated for the period between 1986 and 2023. The high and volatile inflation rates experienced in Türkiye from 1980 to 2001. Then, inflation rates started to decrease since 2002 with the implicit followed by explicit inflation targeting regimes together with the reduction of budget deficits and accomplishment of structural reforms regarding privatization and banking sector. Besides, economic growth rates were higher and more stable in the inflation targeting regimes as compared to those in the other monetary policy regimes. Turkish high inflation experience supports the importance of three pre-requisites necessary for effective implementation of monetary and exchange rate policies that we mentioned at the beginning of the paper: the implementation of fiscal policy and debt finance in a predictable way, political stability and efficiently working banking system.

References

• Bakır, C. (2007). Merkezdeki Banka: Türkiye Cumhuriyet Merkez Bankası ve Uluslararası Bir Karşılaştırma. İstanbul: Bilgi Üniversitesi Yayınları.
• CBRT, internet page (www.tcmb.gov.tr).
• Capie, F., Goodhart, C., & Schnadt, N. (1994). The Development of Central Banking. Cambridge University Press, pp. 4–5.
• Greenspan, A. (2002). “Transparency in Monetary Policy”, Federal Reserve of St. Louis Review, 84(4), July/August: 5–6.
• Tekeli, İ., İlkin, S. (1997). Para ve Kredi Sisteminin Oluşumunda Bir Aşama, Türkiye Cumhuriyet Merkez Bankası, TCMB, Ankara.
• Turkish Statistical Institute, internet page page (www.die.gov.tr).
• Pınar, A., & Erdal, B. (2016). Para Banka Mali Kuruluşlar ve Uluslararası Mali Sistem, Turhan Kitabevi, 3. Bası, Ankara.

1 Introduction

“The Federal Reserve’s experiences over the past two decades make it clear that uncertainty is not just a pervasive feature of the monetary policy landscape, it is the defining characteristic of that landscape.” – Alan Greenspan

In his statement at the American Economic Association meeting held in California in 2004, Greenspan demonstrated the importance of monetary policy uncertainty with these words. Baker et al. (2016) initiated the policy uncertainty calculation methods and later guided the calculation of different uncertainties. Husted et al. (2020) used this methodology to create a monetary policy uncertainty index using monetary policy-related news in newspapers and magazines. Accordingly, the increase in news may affect economic activities by causing an increase in uncertainty. Uncertainties in the economy can be one of the factors explaining economic fluctuations (Caldara et al., 2016). Cascaldi-Garcia et al. (2020) note, “Researchers, policymakers, and market participants are increasingly focusing on the effects of uncertainty and risk on financial market and economic outcomes.” Increased uncertainty typically leads to declines in real GDP, consumption, investment, employment, and interest rates – see, for example, Elder & Serletis (2010), Jurado et al. (2015), and Caldara et al. (2016), among others.

The widespread view in the literature is that economic uncertainties can have a significant impact on the inflation rate, mainly by affecting consumer decisions. Consumers who cannot predict their future income in the economy may tend to save by consuming less in the future. The contraction in consumption expenditures may also lead to a decline in the general level of prices. Similarly, increases in uncertainty affect investors’ decisions, causing investment expenditures to decrease. Therefore, there is an increase in the general level of prices. There are many studies explaining the relationship between prices and uncertainties (Bloom, 2009; Colombo, 2013; Baker et al., 2016; Caldara et al., 2016; Alam & Istiak, 2020; Karagöl, 2023). Although interest in economic policy uncertainty has increased in recent years, studies on monetary policy uncertainty remain limited (Kurov & Stan, 2018; Ugurlu-Yildirim et al., 2020; Azad & Serletis, 2022).

Schaling & Nolan (1998) based the most important way of reducing both monetary policy uncertainty and inflation on the solution of the central bank accountability problem. Yellen (2017) suggested that the 2 % inflation target could be achieved over time by making gradual adjustments in monetary policy and reducing internal uncertainties. Azad & Serletis (2022) proved that US monetary policy uncertainty has negative effects on the macroeconomic and financial fundamentals of emerging markets.

This paper contributes to two literatures. Firstly, it contributes to the uncertainty literature. Higher uncertainty, whether resulting from trade restrictions, political unrest, or the Covid-19 crisis, often has a negative impact on the level of economic activity, and the study proves this. Second, it contributes to the growing international literature on monetary policy uncertainty and time-varying causality.

The article is organized as follows. In Section 2, the Methodology used in the study will be mentioned, and in Section 3, the Data, Model, and Empirical Findings presented. The last section provides a brief conclusion

2 Methodology

The existence and detection of causal relationships are important in determining the interaction mechanism between variables in the economy (Wang & Fu, 2022). If the inclusion of a variable in the model does not improve the prediction of the second variable, this variable is said to be non-Granger causal for the second variable (Balcilar et al., 2010). Granger causality analysis is analyzed using Wald, Lagrange multiplier (LM), and likelihood ratio (LR). Here, the test statistics must be stationary, otherwise, it will cause difficulties in the level predictions of VAR models (Toda & Phillips, 1994). To overcome these difficulties, Toda and Yamamoto (1995) proposed an extended VAR where the coefficients are non-stationary or a modified Wald test to obtain long-term causality estimation of VAR(p) coefficients. If we consider a two-variable VAR(p) process: (1)yt=θ0+θ1yt−1+…+θPyt−p+εt,t=1,2,…,T y1ty2t=θ10θ20+θ11Lθ21Lθ12Lθ22Ly1ty2t+ε1tε2t

where p is the lag order, θijL=∑k=1pθij,kLk,i,j=1,2 and L is the lag operator.