Assessing the Monetary Policy Stance in Turkey Using the Natural Interest Rate

Abstract

This study assesses the monetary policy stance in Turkey using the natural interest rate. In doing so, the study utilizes an empirical framework that estimates the natural interest rate as an unobserved stochastic variable using a parsimonious new Keynesian model consisting of a Phillips curve, an IS curve and a backward-looking Taylor-type interest rate rule. In addition, the model includes stochastic laws of motion for natural interest rate and potential output. Given the dynamic nature of the Turkish economy, the parameters are assumed to be time-varying. This introduces nonlinearity to the system, which can be handled by the Extended Kalman Filter (EKF) algorithm. The analysis results suggest that the estimated natural interest rate is informative about the monetary policy stance. This is especially true after 2010, which is marked by the CBRT’s (Central Bank of the Republic of Turkey) adoption of the new monetary policy mix. The study also addresses the zero lower bound issue, which has dominated the advanced economies after the global crisis. But most importantly, this study underlines the need to find an accurate measure for assessing the monetary policy stance to meet the challenges induced by the post-crisis period.