An evaluation on inflation in Turkey after 1980 and the analysis of relationship between inflation, interest rate and exchange rate

Abstract

Purpose -Interest and exchange rates were determined by market dynamics after adaption of export-oriented industrialization model and liberalization of capital movements in Turkey after 1980s. Important steps have been taken by the Central Bank of Turkey to improve the effectiveness of monetary policy and the execution of monetary and exchange rate policies compatible with free market conditions. However, Turkey experienced chronically high inflation due to the crisis and political imbalances. In this study, the causality relationship between inflation, interest rate and exchange rate is evaluated. Methodology -The relationship between inflation, interest rates and exchange rate are investigated by VAR Method for 2003: 01-2015: 02. The causality relationship between the variables are investigated by Granger causality analysis. Then, by impulse response analysis the responses of the variables to one-unit shocks and by variance decomposition analysis the explanatory of the variables on each other are investigated. Findings-After 2008 global crisis, by 2010, the Central Bank adopted financial stability as well as price stability in monetary policy implementations. It is necessary to re-analyze the relationship between inflation, exchange rate and interest rate due to the changes in implementations against inflation during this period. The causality relationship between variables are examined by Granger ca usality test. As a result, a causality relationship from the interest rate to inflation is determined. Conclusion-In this study the relationship between inflation, interest rate and exchange rate is examined in Turkey for 2005-2016 period. Findings of analysis result that interest rate is an effective variable on inflation and inflation rate is mostly affected by fluctuations in interest rates. Interest rates can be used as a policy tool against inflation which was the case for Turkey in the near past.