Abstract
The purpose of this study is to determine the relationship between monetary policy and the exchange market pressure index in Turkey for the 2002–2018 period with monthly data. To obtain the foreign exchange market pressure index, this study uses the model developed by L. Girton and D.E. Roper and is based fundamentally on the monetary approach to exchange rate determination and the balance of payments. The calculated exchange market pressure index is in accordance with the developments lived in financial markets and changes in monetary policy during the period under investigation. As for the relation between exchange market pressure index and monetary policy, a VAR model was set up and a Granger type causality analysis was carried out. According to Granger causality test results, there is a unidirectional causality running from domestic credit expansion to exchange market pressure and from domestic credit expansion to interest rate differential while there is a bidirectional causality between exchange market pressure and interest rate differential. Since increasing exchange market pressure means a depreciation of the Turkish Lira, the estimated VAR model’s results support the view that the Central Bank will increase the interest rate to temper the exchange market pressure.
Highlights
Developing countries often face problems in the foreign exchange market, so policy choices are important for macroeconomic stability
The foreign exchange market pressure simultaneously and positively reacts to the domestic credit shock and this reaction proceeds in a gradually declining manner throughout six months. This supports the traditional theoretical expectation that domestic currency appreciates and international reserve volume increases if the Central Bank engages foreign currency purchasing transactions to draw the excess liquidity in the market
If we consider the fact that this response is short lived and limited, we can say that measures that aim to defend the value of domestic currency should contain small scaled and temporal interventions without creating fundamental changes in international reserves
Summary
In order to overcome these limits set by traditional models, the foreign exchange market pressure criterion, developed by Girton & Roper, can be applied in fixed, fully flexible and managed floating exchange rate systems. This study aims to estimate the extent of exchange market pressure in Turkey for the period 2002–2018 and evaluate the effectiveness of monetary policy. The present study differs from previous ones in the context of applying Girton & Roper Model for the period of inflation targeting monetary policy and floating exchange rate regime. For this purpose, the second section discusses foreign exchange market and monetary policy developments in the corresponding period in Turkey. The fourth section aims estimating the model and evaluating the results and, the fifth section concludes the study and provides some policy recommendations
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