erc/metu
INTERNATIONAL CONFERENCE IN ECONOMICS  IV
September 13-16, 2000, Ankara

From Crawling Peg to Inflation Targeting

Elif Sisli (Asian Development Bank Institute, JAPAN)

Abstract  

Currently, explicit nominal exchange rate targeting (crawling-peg exchange rate policy) co-exists with an implicit inflation-targeting in Turkey, where inflation becomes the residual consequence of targeting the nominal exchange rate. Although Leidermann and Svensson (1995) state that under a crawling band regime, the two targets can coexist "as long as it is clear that inflation target has priority as conflict arises," any course of action by the monetary authority (letting the exchange rate move out of the promised band or adjusting the monetary policy instrument at the expense of the indicated inflation target) would diminish its credibility. If the overriding objective of the monetary authority is to establish and maintain the price stability, the most viable policy would be to increase the emphasis on the inflation target. This paper investigates the possibility of transition from the crawling peg regime to inflation (forecast) targeting as the monetary policy framework for Turkey, both from institutional perspective (independence of the central bank, fiscal dominance) and technical/operational perspective (choosing the target, its band, horizon and the analytical framework linking policy instruments to inflation). The technical applicability of the proposed policy is checked via: (i) identifying the leading indicators (monetary aggregates, exchange rates, real activity, labor market, fiscal, financial market and external variables) of the selected measures of inflation (CPI and private manufacturing price index) bivariate Granger Causality tests, (ii) building a pragmatic reduced form of inflation equation (VAR) using the strongest leading indicators, and (iii) checking the forecast errors by performing out-of-sample prediction. Malatyali (1998) investigated the applicability of inflation targeting from an institutional perspective and concluded that it could be applicable after a transitionary period. The results of this study complement her analysis, and envisage an optimistic institutional and operational environment for the implementation of inflation targeting in Turkey, once the inflation level İstanbul Üniversitesi brought down to promised levels at the end of the two-year crawling peg regime which would serve as the transition period.

Economic Research Center
Middle East Technical University
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