The Divergence of Bank Lending Rates from Policy Rates in Turkey: A Monetary Experiment or an Unconventional Approach in Dealing with High Inflation

Abstract

The study examines the impact of the divergence between policy rates and lending rates on inflation in Turkey, with a specific focus on the role of adaptive expectations. The analysis covers a long period, from January 2003 to January 2023, and includes six countries: Germany, France, Italy, Spain, US, UK and Turkey. The study finds that there is a persistent and significant divergence between policy rates and lending rates in Turkey. Additionally, the depreciation of the currency has a significant impact on lending rates in Turkey, as it increases both the cost of borrowing for banks and the cost of funding for businesses and consumers. Moreover, the study suggests that adaptive expectations play an important role in the relationship between policy rates, lending rates, and inflation. Past inflation rates have a significant impact on current inflation expectations, which, in turn, influences the inflation rate. This phenomenon is exacerbated by borrowers demanding higher lending rates to compensate for the increased risk in an environment of high inflation and uncertain policy, further widening the gap between policy rates and lending rates. The study's findings provide valuable insights into the complex dynamics of monetary policy, lending rates, inflation, and the exchange rate in soft currency economies such as Turkey. The results highlight the importance of addressing the issue of the divergence between policy rates and lending rates, while taking into account the impact of adaptive expectations and the exchange rate on inflation dynamics.