An Analysis of Determinants of the Real Exchange Rate on Axis of the Capital Flows Volatility in Turkey

Abstract

Real exchange rate is a relative price that keeps the domestic and foreign balance by measuring a country’s foreign competitive structure and provides macroeconomic adaptation. In an economy, current account is no longer equal to the capital account in the presence of capital flows and therefore such flows can affect real exchange rates. Real exchange rate will devaluate when capital flows are weaker and ending this loss becomes dependent on capital movements between countries. While in traditional models capital inflows can create an expansive effect (growth), on the other hand sudden capital outflows in the short term can lead to a recession. Such models demonstrate that capital inflows can cause an expansion of total demand, rapid monetary expansion, inflationist pressure, appreciation of real exchange rate and increased current deficit. This study uses the VAR method to analyse “the impact of volatile capital flows on real exchange rate” in Turkey in the 1994:Q4-2013:Q2 period. After checking the impact of other financial control variables for Turkey, it can be said that volatile capital flows devaluate real exchange rates.