Monetary Policy in Turkey: The Reasons for Introducing IT and the Outcome

Abstract

Inflation targeting (IT) was introduced to Turkish practice as well as to its intellectual environment along with the measures taken after the 2001 crisis. The dramatic failure of the exchange rate-based monetary policy that was tried out in 2000–1 left Turkey in practice with only one untried option: IT. The Central Bank of the Republic of Turkey (CBT) switched to a fully fledged IT policy after a transition period, which was referred to, for convenience, as ‘implicit IT’.¹ The CBT made it clear that whenever the necessary conditions were satisfied it would switch to fully fledged IT. On the other hand, the CBT revealed what it meant by ‘necessary conditions’ by underlining two major concerns. The first and more important concern was fiscal dominance: public debt was almost 75% of GDP,² a situation that had led to debt sustainability concerns, which reflected themselves in high spreads and real interest rates. The second concern was that the financial sector and non-financial corporations were severely affected by the crisis, and the resulting balance sheet problems were putting serious constraints on the efficient implementation of fully fledged IT. There were other challenges as well: high pass-through and backward-looking pricing. In addition, the CBT obviously needed some time to complete the necessary institutional arrangements for effective IT (such as its communication strategy).