Drivers of Turkish Inflation

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Abstract

This paper investigates the drivers of Turkish in‡ation by using a structural vector autoregression model, where monthly data on global oil prices, unemployment rates, in‡ation rates, policy rates and exchange rates are used. The empirical results show that Turkish in‡ation increases following a negative policy rate shock, a positive exchange rate shock, or a positive global oil price shock. The volatility of Turkish in‡ation is mostly explained by global oil prices and exchange rate movements in the long run, while the contribution of exchange rate shocks to Turkish in‡ation has continuously increased over time. As additional empirical results show that exchange rate depreciation can be reduced by positive policy rate shocks, it is implied that a conventional monetary policy increasing policy rates following an increase in in‡ation or a depreciation of Turkish lira would be optimal to achieve and maintain price stability in Turkey, which is the primary objective of the Central Bank of the Republic of Turkey. JEL Classi…cation: E31, E52, F41 Key Words: Monetary Policy; In‡ation; Unemployment; Exchange Rate; Turkey. The author would like to thank the editor Hadi Salehi Esfahani and two anonymous referees for their helpful comments and suggestions. The author is also grateful for Kimberly Green Faculty Fellowship and the Steven J. Green School of International and Public A¤airs for their continuous support. yDepartment of Economics, Florida International University, Miami, FL 33199, USA. Phone: 305-3482316. Fax: 305-348-1524. E-mail: hyilmazk@…u.edu 1 Drivers of Turkish In‡ation Abstract This paper investigates the drivers of Turkish in‡ation by using a structural vector autoregression model, where monthly data on global oil prices, unemployment rates, in‡ation rates, policy rates and exchange rates are used. The empirical results show that Turkish in‡ation increases following a negative policy rate shock, a positive exchange rate shock, or a positive global oil price shock. The volatility of Turkish in‡ation is mostly explained by global oil prices and exchange rate movements in the long run, while the contribution of exchange rate shocks to Turkish in‡ation has continuously increased over time. As additional empirical results show that exchange rate depreciation can be reduced by positive policy rate shocks, it is implied that a conventional monetary policy increasing policy rates following an increase in in‡ation or a depreciation of Turkish lira would be optimal to achieve and maintain price stability in Turkey, which is the primary objective of the Central Bank of the Republic of Turkey.This paper investigates the drivers of Turkish in‡ation by using a structural vector autoregression model, where monthly data on global oil prices, unemployment rates, in‡ation rates, policy rates and exchange rates are used. The empirical results show that Turkish in‡ation increases following a negative policy rate shock, a positive exchange rate shock, or a positive global oil price shock. The volatility of Turkish in‡ation is mostly explained by global oil prices and exchange rate movements in the long run, while the contribution of exchange rate shocks to Turkish in‡ation has continuously increased over time. As additional empirical results show that exchange rate depreciation can be reduced by positive policy rate shocks, it is implied that a conventional monetary policy increasing policy rates following an increase in in‡ation or a depreciation of Turkish lira would be optimal to achieve and maintain price stability in Turkey, which is the primary objective of the Central Bank of the Republic of Turkey. JEL Classi…cation: E31, E52, F41