De Facto Monetary Policy under Inflation Targeting in Turkey

Inflation targeting has become a favored monetary policy strategy since the early-1990s in both developed and developing countries. Turkey has followed this track in the post-2001 period, namely after a major financial crisis. There is a growing body of theoretical and empirical literature about the dependency of peripheral economies’ monetary policy on the international monetary and financial system. Given that Turkey is a typical example of a peripheral economy, the main research question that this study poses is whether de facto monetary policy has been in line with the de jure form – inflation targeting – in the post-2001 period. To answer this research question, certain policy scenarios regarding the reaction of the interest rate to (expected) exchange rate and (expected) inflation rate have been set forth. Descriptive statistics have been used to bring empirical support to the policy scenario analysis. The research results show that the de facto monetary policy of Turkey has considerably differed from inflation targeting in the sense that (expected) exchange rate has been a significant factor in determining the movements in policy interest rate. This type of monetary policy can be considered as a managed exchange rate regime. In short, inflation targeting has been dysfunctional in Turkey. When Turkey was convinced by this dysfunctionality in late 2010, monetary policy was highly modified, which is an important policy step towards a more domestic-oriented monetary policy.