Influence of Exchange Rate on the Economic Growth in the Turkish Economy

Introduction. In 2020, the COVID-19 pandemic quickly spread to almost all countries, causing a downturn in the economy and worsening monetary stability. In terms of the scale of its effects, this stress even exceeded the impact of the global financial crisis. It was quite logical to revise the parameters of monetary policy, including lowering (or keeping low) key policy rates, accepting long-term refinancing operations, and reducing the required reserve ratio. All of these measures were intended to stimulate the economy, and the recent practice deserves an examination of how effective the transmission of monetary policy has been. Problem Statement. The implementation of monetary policy in the context of the pandemic is giving rise to new academic discussions about transmission channels, as well as the combination of the general and the particular in the context of countries. The purpose is to examine the transmission mechanism of monetary transmission to achieve the inflation target and ensure sustainable economic growth of the national economy. Methods. General scientific and specific methods of scientific cognition were used. In particular, the study used system analysis to describe models of the monetary policy transmission mechanism; abstract and logical analysis to summarize and build logical links between individual links in the monetary policy transmission mechanism; and statistical and economic analysis to analyze the impact of monetary transmission on inflation under the inflation targeting regime. Methods. System analysis was used to describe models of the transmission mechanism of monetary policy; abstract-logical – for summarizing and building logical connections between separate links of the transmission mechanism of monetary policy; statistical and economic - to analyze the impact of monetary transmission on inflation within the framework of the inflation targeting (IT) regime. Results. Transmission channels are defined as the chain of transmission of the impact from the key policy rate (discount rate) to the next link in the monetary transmission chain. Because of its properties (systematicity, consistency, and microfoundedness), neo-Keynesian logic is well suited to the main macroeconomic models that belong to the class of structural models (including both classical DSGE and semi-structural models). The model used by the National Bank of Ukraine to describe the transmission and build a medium-term forecast of the domestic economy also belongs to the class of structural models. A structural model in the neo-Keynesian logic combines the three most powerful transmission channels - interest rate, exchange rate, and expectations channels. An impulse in the key policy rate is instantly reflected in the 10-day interbank lending rate, and this rate is therefore the NBU's operational target for monetary policy. From the interbank lending rate, the impact of monetary policy is transmitted further to rates in other segments of the money market. Changes in interest rates affect the consumption and investment decisions of economic agents. From market interest rates and financial asset yields, the monetary policy impulse spreads further to lending activity and balance sheet indicators of companies and banks. Changes in the key policy rate affect prices and the value of assets on companies' balance sheets. From the credit sector, the impulse is smoothly transferred to economic activity and inflation. Aggregate demand, expectations, the exchange rate, and producer costs respond to monetary policy. Monetary policy affects expectations and, consequently, inflation by creating an “anchor” for its expected level in the medium term. Conclusions. Achieving the inflation target through the use of the IT regime is an important condition for achieving macroeconomic stability. The NBU's transition to IT was justified, as evidenced by the proven hypothesis of a sharp decline in inflation and price volatility in the medium term. Prices stabilized through the expectations channel. A timely response to the challenges of the pandemic should be accompanied by an easing of monetary policy aimed at reducing the cost of financial resources and restoring long-term lending to the economy. The experience gained enabled the banking system to withstand the next shock - a full-scale Russian aggression against Ukraine, using proven approaches. Studies have shown that the inflation target of 5% ± 1 p.p., which is optimal from the NBU's point of view, does not affect economic growth. The use of the key policy rate instrument demonstrates a delayed reaction of market participants with a lag of 9-18 months. The regulator focuses on the inflation target and, once it is achieved, on measures to support inflation within the planned target. Resolving the dilemma between the planned inflation rates and maintaining economic growth requires regulatory changes to the laws governing the central bank.

Whether the adoption of an inflation targeting (IT) regime reduces exchange rate volatility has been a heated debate and a subject of intense research. On the one hand, exchange rate volatility can be addressed by managing the inflation rate. On the other hand, exchange rate volatility cannot be manipulated by interest rates as the main instrument in the inflation targeting regime. This article aims at examining the impact of inflation targeting regime on exchange rate volatility. Taking the case of Indonesia over the period 2000(1)–2022(12), we found that the targeted inflation lowers inflation rate instability. However, our two-stage generalised autoregressive heteroskedasticity conditional model estimation concludes that inflation volatility induces exchange rate volatility. Accordingly, announcing higher inflation targets may not be costly to reduce inflation uncertainty, resulting in a decline in exchange rate volatility. Furthermore, market intervention can symmetrically mitigate exchange rate volatility. Accordingly, market intervention is needed as an additional instrument for macroeconomic stabilisation. In other words, the optimal stock of foreign reserves (FR) management might avoid Indonesia’s monetary authority to impose dual goals of inflation and exchange rate stability. JEL: E31, E58, F31, F41

The deterioration in credibility, destabilization of exchange rate and the rise in exchange rate pass-through in Turkey

The paper analyzes the differences in managing exchange rate fluctuations in an inflation-targeting monetary framework in the case of (former) transition economies. Differences in managing the exchange rate fluctuations are identified according to the extent of managing as hard (dirty) versus soft managed floating, on the one hand, and according to direct managing via foreign exchange interventions and indirect managing via interest rate policy, on the other hand. Hard versus soft managed floating (sub)regimes are related to inflation-targeting (sub)regimes: hard managed floating with light inflation targeting and soft managed floating with strict or full-fledged inflation targeting. Two main motives for managing exchange rate fluctuations are emphasized in the paper: exchange rate pass-through and financial euroization. The direct and indirect managing of exchange rate fluctuations, exchange rate pass-through, and financial euroization, are investigated with vector autoregression (VAR)/vector error correction (VEC) models in the case of Poland, the Czech Republic, Slovakia, Hungary, and Serbia, in the period of combining flexible exchange rate regimes and an inflation-targeting monetary regime. The comparison of investigated indicators provides conclusions and lessons for the Serbian monetary authorities in the sense of conducting the current combination of managed exchange rate floating and an inflation-targeting regime.

In January 2002, the Central Bank of Turkey (CBT) moved to an implicit inflation targeting framework, which included core attributes of an inflation targeting (IT) regime including, among other requirements, the announcement of a formal target for inflation. As a result of successful disinflation, prudent fiscal policy and implementation of reforms, Turkey introduced a full-fledged IT regime in 2006, which brought further transparency to the monetary policy framework. We found that during 2002–2006, among other factors, the developments in Turkey's risk premium played a very significant role in the path of policy rates. We arrived at this conclusion by estimating a Taylor rule describing the policy reaction function of the CBT. During this period exchange rate pass-through to inflation declined, and while capital inflows strengthened the real exchange rate, the nominal exchange rate and the financial markets in general were affected by occasional reversal of capital inflows. We offer a short discussion of CBT reaction to sudden stop episodes under the new monetary regime. Particularly, we ask whether the sharp increase in policy rates in response to the mid-2006 episode was a defense of the currency instead of adherence to an open economy IT regime. We also discuss whether softening of the targeted disinflation path may have been a viable option.

Since Jan 4th 2016, the State Bank of Vietnam (SBV) has applied the central exchange rate regime pegging VND to a basket of 8 currencies, which reflects the adaptation of macro policies in general, exchange rate policy in particular when integration context has changed. In order to propose suitable solutions to administrate exchange rate policy effectively, this article employs the VAR model, in which the relationship between exchange rate and three objectives of exchange rate policy (including prices, output and trade balance) are tested. The data used in this model is quarterly, in the period 2001q1-2017q3. Based on the results of the VAR model, a number of policy implications has been proposed, including: (i) continuing to apply currency basket pegged exchange rate regime; (ii) in stead of choosing to devaluate VND, the SBV should use other exchange rate management tools; (iii) speeding up the development of derivative exchange rate market is necessary to reduce the level of ERPT to the import price index so that helps to control inflation in Vietnam and (iv) the SBV should prioritize the exchange rate policy administration towards price stability through adopting the inflation-targeting monetary policy.
 Keywords
 Exchange rate policy, exchange rate, inflation, economic growth, trade balance
 References
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The yield curve and the macroeconomy: Evidence from Turkey

This paper investigates the relationship between exchange rate and inflation targeting regime in six emerging economies which have adopted inflation targeting (IT) regime during the period of 1993M1-2013M7. In this study, we seek to examine how the adoption of inflation targeting influenced exchange rate pass-through (ERPT) and volatility. The empirical evidences suggest that ERPT has declined after IT adoption for both price indexes (consumer and producer prices) for most economies analyzed. Furthermore, our results show that IT regime can reduce exchange rate volatility and inflation volatility in all countries. Thus, the implementation of inflation targeting regime contributes to price stability through the decline of exchange rate pass-through and exchange rate volatility.

Purpose- The aim of this study is to empirically investigate the relationship between the change in exchange rates and the profitability of firms in Turkey. The changes in real effective exchange rate as the change in exchange rates criteria and return on assets as well as return on equity are considered for measuring profitability.Methodology- The sample of the research consists of 37 companies that are listed in BIST 100, operating in the manufacturing sector and whose data can be accessed completely. The data of the companies within the scope of the research were obtained from the official websites of Borsa Istanbul, Public Disclosure Platform, and Finnet and made ready for analysis. For the purpose of the research, panel data analysis, panel unit root tests, panel regression analysis, causality analysis, and moderating effect analysis were carried out.Findings-. Changes in foreign exchange rates, foreign sales and asset size of the companies do not have any significant impacts on the return on assets and return on equity during the period between 1999-2019 in Turkey. It has also been found that asset size, foreign sales, and change in exchange rates are the reasons for the return on assets and similarly, asset size, foreign sales, and change in exchange rate are the reasons for the return on equity. Finally, changes in the foreign exchange rate and export sales have a short-term causal relationship with both return on assets and return on equity, and changes in the foreign exchange rate and total assets have a moderating effect on return on assets.Conclusion- As a result of the research, it has been revealed that firms are affected by changes in foreign exchange rates with a delay. It means firms were likely be affected by the changes in exchange rates with a lag, and similarly, the changes in exchange rates affected financial performance with a lag. It has also been revealed from the research that firms effectively use internal and external hedging methods that help reduce the adverse impacts of the changes in foreign exchange rates.

While many have underscored the role of a flexible exchange rate policy under an inflation targeting (IT) regime, very few studies have examined what actually happens to exchange rate policy once the emerging market announces that it will adopt inflation targeting. The central contention of this paper is that while the adoption of an inflation targeting (IT) policy may lead to more flexible exchange rate movements, for various reasons it is possible that the degree of flexibility will be significantly higher on one side of the market. In this study, we demonstrate that four Asian economies—namely, Indonesia, Korea, the Philippines and Thailand—whom were among the first group of emerging markets to embrace the inflation targeting framework of monetary policy, tend to adopt a form of asymmetrical exchange rate behavior, wherein appreciation pressures are restrained more substantially than depreciation pressures.

Economic literature shows evidence that a competitive real exchange rate (RER), i.e., slightly undervalued, is key for development in developing countries. This paper discusses the connections between inflation targeting (IT) regimes and RER trends in economies highly open to capital flows. Following Rodrik’s (2008. The real exchange rate and economic growth, Brookings Papers on Economic Activity, Washington, 2008, vol. 39, no. 2 (Fall), 365–439), the RER trend is estimated for a sample of 31 out of the 38 developed and developing countries that, by the final year of the period covered in this study (2019), had already adopted IT. Covering the period 2000–2019, we showed that all developed and Latin American developing countries had an RER overvaluation trend, while the European, Asian and African (South Africa) developing countries registered an undervaluation trend in the same period. Through a dynamic panel data model, we tested and validated the following hypotheses, which, to the best of our knowledge, are a seminal contribution. We found in Latin American developing countries, whose ITs are centred on the main objective of pursuing price stability, the RER overvaluation trend (a by-product of this monetary policy regime) is driven by higher interest rate differentials to the USA and is harmful to their economic growth. In developed countries, this trend is not explained by their IT framework but by their high per capita income level, which reflects their high average labour productivity and development pattern. Yet, the trend of RER undervaluation in Asian and European developing countries and South Africa reflects their governments’ ability to combine a more flexible IT regime with a floating but managed exchange rate system aimed at preserving a competitive and stable RER in the long term.

Exchange rate pass-through: A comparative analysis of inflation targeting & non-targeting ASEAN-5 countries

This chapter reviews the evolution of Moldova’s inflation targeting (IT) regime since its introduction in 2013, focusing on the National Bank of Moldova’s (NBM) operational framework in a challenging macro-financial environment. Inflation has been volatile and largely driven by exogenous factors, including food, fuel, regulated energy prices, and high exchange rate pass-through, complicating the conduct of IT in a small, open, and partially dollarized economy. Empirical evidence shows that monetary policy initially reacted mainly to exchange rate movements, targeting inflation only indirectly. Since 2020, policy has shifted toward a more conventional IT framework, with systematic responses to the inflation gap, reduced foreign exchange intervention, and strengthening monetary transmission. The chapter also assesses the costs of high reserve requirements and discusses options for their gradual normalization.

Job creation is at the centre of economic development and remains a source of sustenance for social and human relations. The creation of a job-enabling economic environment is imperative in promoting social and economic cohesiveness in the macro and microeconomic environment. Any shocks to the economy, particularly those of exchange rate shocks and changes in economic growth, may negatively affect the labour market and job creation. This study made use of quarterly observations, from the first quarter of 1995 to the fourth quarter of 2015, to investigate the effect of the real exchange rate and economic growth on South Africa’s employment status. South Africa, a developing country, was selected as a case study due to its high unemployment rate that is still increasing. The Vector Autoregressive (VAR) model and multivariate co-integration techniques were used in assessing the impact and responsiveness of employment to the real exchange rate and real economic growth in South Africa. Findings of this study revealed that employment responds positively to economic growth and negatively to the real exchange rate in the long-run. The short-run displays a positive relationship between real economic growth and employment, while the relationship between employment and the real exchange rate is also negative. However, the effect of economic growth in creating jobs is not significant enough in stimulating job creation in South Africa, as indicated by results in variance decomposition. Movements in the exchange rate exerted a significant short and long-run negative effect on employment dynamics; implying that a depreciation of the rand against the U.S. dollar is associated with decrease in overall employment. Exchange rate stability is thus important for economic growth and job creation in South Africa. The study provided further recommendations on promoting job creation in South Africa and other developing countries.

Especially, after the 2000s, many developing countries let exchange rates float and began implementing inflation targeting regimes based on mainly manipulation of expectations and aggregate demand. However, most developing countries implementing inflation targeting regimes experienced considerable appreciation trends in their currencies. Might have exchange rates been utilized as tools even under inflation targeting regimes in developing countries? To answer this question and investigate the determinants of inflation under an inflation targeting regime, as a case study, this paper analyzes the Turkish experience with the inflation targeting regime between 2002 and 2008. There are two main findings of this paper. First, the evidence from a Vector Autoregressive (VAR) model suggests that the main determinants of inflation in Turkey during this period are supply side factors such as international commodity prices and the variation in exchange rate rather than demand side factors. Since the Turkish lira (TL) was considerably over-appreciated during this period, it is apparent that the Turkish Central Bank benefited from the appreciation of the TL in its fight against inflation during this period. Second, our findings suggest that the appreciation of the TL is related to the deliberate asymmetric policy stance of the Bank with respect to the exchange rate. Both the econometric analysis from a VAR model and descriptive statistics indicate that appreciation of the Turkish lira was tolerated during the period under investigation whereas depreciation was responded aggressively by the Bank. We call this policy stance under the inflation targeting regimes as implicit asymmetric exchange rate peg. The Turkish experience indicates that, as opposed to rhetoric of central banks in developing countries, inflation targeting developing countries may have an asymeyric stance toward exchange rates and favour appreciation of their currencies to hit their inflation targets. In this sense, IT seems to contribute to the ignorance of dangers regarding to over-appreciation of currencies in developing countries.