Monetary Policy, Uncertainty, and Domestic Shock Transmission to Capital Flow in Turkey

Abstract

This paper reports findings on multiple important phenomena in capital flow literature: internal and external shock transmission to foreign direct investment and foreign portfolio investment. Operating on Turkey as a case study, I disaggregate quarterly gross capital inflows (FDI and FPI) and examine their time-varying responses to shocks in advanced economies' monetary policy and uncertainty surrounding it, Central Bank of Turkey's monetary policy, and several key domestic macroeconomic determinants. To this end, I employ a recently developed Structural Vector Autoregression technique that uses a data-driven non-Gaussian approach and find that FPI inflows are considerably more sensitive to permanent unexpected monetary policy shocks originating both at home and abroad. Complementary results from uncertainty metrics indicate-to varying extents-that Turkey is a beneficiary of capital flow amidst heightened policy tension in the US. I also visit the push-vs.-pull debate in capital flow literature via Forecast Error Variance Decomposition and discover that Turkey falls decisively in the pull category. The Turkey-specific indicators most crucial in attracting foreign capital are the performance of the currency and CBRT's policy positioning. Lastly, using signal-processing techniques in the time-frequency domain, I report that higher FPI inflows have generally led FDI inflows in times of global economic turbulence, but that phenomenon is undergoing a reversal in the recent past.