Monetary Condition Index with Time Varying Weights: An Application to Turkish Data

Abstract

In this study, the evaluation of the impact of the fluctuations in interest rate and exchange rates on monetary policy is carried out through the use of Monetary Conditions Index (MCI). The weights for construction of MCI are derived using the time varying framework with Kalman Filter algorithm. Despite the simplifying assumptions made during its construction, the time varying version of MCI provides opportunities for the analysis of the contribution of the monetary conditions to the evaluation of Turkish economy, especially in recent past when it is compared to traditional constant weighted MCIs. According to the fundamental result obtained in the study, the changes in inflation give rise to changes in both interest rates and exchange rates. Moreover, the result obtained also demonstrates that the interest rate channel, when compared to exchange rate channel, have a stronger and more rapid impact on the transfer of the changes in policies to economy.