Observations on the Practice of Central Banking in Turkey Refet S. Gürkaynak Bilkent University

Three steps to central banking Make a forecast about the future state of the economy Decide on the overnight interest rate that will steer the economy toward a desired direction Implement the policy in the money market

Forecast the future state of the economy… Use historical relationships between variables Difficult in Turkey—history is too “different”  1970’s: Mostly closed economy  1980’s: Nonconvertible lira  1990’s: Boom-bust cycles  After 2001: Mostly “normal” economy What does a 10% increase in oil prices do?  In the US? In Turkey?

Decide on optimal policy Difficult for the reason above Little information on the transmission mechanism What does monetary policy do? How does it work in Turkey?  Depends on the perception of the fiscal situation, state of the world business cycle…  The evolving credibility of the central bank

A friend having similar difficulties The European Central Bank  Short history German reunification Changing definition of eurozone  New countries being added  Evolving policy framework  Evolving credibility

Given these difficulties All the more remarkable performance from the Central Bank of Turkey over the past five years  Successful disinflation  Improved communication  Increased credibility

Inflation Targeting in Turkey Timely  After successful disinflation IT began with a well regarded central bank Less need for credibility building  When economy stabilized Agents began to have a longer horizon Needed guidance, anchoring  Important communication tool

IT has helped… …during the recent fluctuation The central bank only needed to display commitment to an already known target  Not having to communicate policy objective when markets have seized up helps

Impact of the 175 bp rate hike on the yield curve From Akıncı et. al (2006)

Credibility building in practice The rate hike has led to higher interest rates up to a year But to lower rates after a year  Rates lower because of lower expected inflation and inflation risk Displayed commitment to the inflation target Leading to increased credibility

Conclusions After 2001 Turkey is more like the normal, textbook economy But we are still learning about the economy  Including the central bank Central bank has been successful in tough circumstances Credibility building is continuing  Learning about the central bank by the public  Eventually the central bank will not have to signal commitment—it will be known