Abstract
US sub-prime crisis in 2008–09 led the central banks undertake unconventional monetary policies. In turn, short-term and volatile capital flows into emerging markets surged significantly, reigniting an intense academic debate on the ability of the central banks in EMs to protect their financial markets from external shocks. This paper develops a partially integrated System Dynamics Model to simulate the impact of the capital flows on the dynamics of the nominal exchange rate in Türkiye. The results support the contention that several recent episodes of excessive depreciation of the Turkish Lira as well as the currency crisis of 2018 can be linked to the reversals of stocks of short-term FX liabilities. The model also integrates policy rate sub-module into the main model, allowing responses of the central bank to inflation and exchange rate as a feedback mechanism. The results of the module indicate that external factors may cause the central bank to loose monetary independence in order to maintain financial stability.
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