Modeling the exchange rate pass-through in Turkey with uncertainty and geopolitical risk: a Markov regime-switching approach

Abstract

Purpose This paper aims to investigate the pass-through (PT) effect in Turkey by using quarterly data for the period 1998: Q1-2019: Q2 to understand the dynamic potential effects of exchange rates on domestic prices. Design/methodology/approach The paper launches several nonlinear models in which the basic determinants of domestic prices in Turkey are determined through Markov regime-switching models (MSMs). Hence, this research follows the variables of the consumer price index (CPI), USD exchange rate, gross domestic product (GDP; demand side of the economy), industrial production index (production side of the economy), economic uncertainty and geopolitical risk index for Turkey. Findings This work explores that the exchange rate and demand side of the economy (GDP) follow a positive nonlinear relationship with CPI at both regimes. The production side of the economy (IP) affects negatively the CPI during regime 0. Economic uncertainty influences the CPI positively at Regime 1, while geopolitical risk has a negative association with CPI at Regime 0. Eventually, the paper provides some policy proposals associated with the impacts of GDP, IP, economic uncertainty and geopolitical risk on CPI in Turkey. Originality/value One may claim that any PT model, which does not observe the possible structural or regime shifts in estimated parameters, might fail to estimate the coefficients unbiasedly and efficiently. Hence, this work differs from available relevant works in the literature since this paper considers linearity or nonlinearity important and reveals that the relevant PT model follows a nonlinear path rather than a linear path, this nonlinear path is converged strongly by MSMs and estimates the significant regime shifts in the constant term and, in parameters of independent variables of PT by MSMs.

Impact of fiscal deficit and trade openness on current account deficit in India: new evidence on twin deficits hypothesis

“…It can be inferred from the estimates that an increase in the exchange rate will impact the current account balance by making imports cheaper and exports more expensive. This relationship supports Mundell–Fleming model (Bilgili et al. , 2021; Fleming, 1962; Mundell, 1963; Taneja & Ansari, 2016; Vieira & MacDonald, 2020).…”

“…It can be inferred from the estimates that appreciation of the exchange rate will increase the CAD in India. Indian CAD leads to the appreciation of the currency, making exports more expensive and less competitively priced in international markets (Bilgili et al. , 2021; Fleming, 1962; Missio & Gabriel, 2016; Mundell, 1963; Taneja & Ansari, 2016; Vieira & MacDonald, 2020) resulting in the reduction of the exports and an increase in imports.…”

“…It can be inferred from the estimates that appreciation of the exchange rate will increase the CAD in India. Indian CAD leads to the appreciation of the currency, making exports more expensive and less competitively priced in international markets (Bilgili et al, 2021;Fleming, 1962;Missio & Gabriel, 2016;Mundell, 1963;Taneja & Ansari, 2016;Vieira & MacDonald, 2020) resulting in the reduction of the exports and an increase in imports. This gap between exports and imports will result in a higher CAD because developing countries like India are net importers (see, Ahmed, 1986;Bhat & Sharma, 2018;Darrat, 1988;Feldstein, 1982;Mohanty, 2019).…”

“…The Mundell–Fleming model also explains how the fiscal and trade deficits are connected. The model describes how budget deficits drive domestic interest rates to increase, which leads to capital inflows and exchange rate appreciation (Fleming, 1962; Mundell, 1963; Bilgili, Ünlü, Gençoğlu, & Kuşkaya, 2021). As a result, it will have an impact on the balance of payments by making imports cheaper and exports more expensive.…”

Nexus between economic risk and political risk in the United Kingdom: Evidence from wavelet coherence and quantile‐on‐quantile approaches

“…Bilgili, Ünlü, et al. (2021) use Markov regime‐switching approach for Turkey and report that economic uncertainty influences the CPI positively at regime 1, while geopolitical risk impacts the CPI negatively at regime 0 positively. Furthermore, Bilgili et al.…”