The Policy Challenge at Floating Exchange Rates: Turkey's Recent Experience

Abstract

This paper evaluates the developments in the Turkish economy in light of the Central Bank's policies during a recent period of floating exchange rate system. It is found that the Central Bank was effective in containing volatility and reducing the average inflation rate while there was a strong recovery of the output. However, there are accumulated risks in the economy. Particularly, the extreme appreciation of the Turkish lira during this period and the record level of real interest rates give the impression that the current state of the economy is fragile. Unless the government accelerates structural reform process and pursues sound fiscal policies to reduce the public sector borrowing requirement and the debt ratio, any adverse shock to the system may trigger a reversal of fortune.