Revisiting the Tinbergen Rule: use the macroprudential tools to maintain financial stability

Capital flows to emerging market economies, which have intensified recently due to better growth prospects, interest rate differentials, and better risk perceptions, have the potential to destabilise financial systems in these countries which are typically neither diversified nor deep enough to absorb such flows. While tools to manage large capital flows are well known, the appropriate policy mix depends on country-specific circumstances. Fiscal policy, monetary policy, exchange rate policy, foreign exchange market intervention, macroprudential tools, and capital controls could be used to cope with the volatility of capital flows, but each of them entails some tradeoff. The challenge faced by central banks is to establish a framework that combines both price and financial stability as primary objectives and identify policy instruments to target both, even at times they seem to conflict with each other. In today’s challenging financial environment, public authorities in Turkey have underscored four basic principles upon which the fiscal, monetary and regulatory policies would be built to maintain financial stability. These are (1) use of more equity, less leverage; (2) extending the duration of borrowing; (3) strengthening the foreign exchange position and use of local currency in borrowing; and (4) better management of foreign currency risk. This approach aims to use current global financial environment as an opportunity to strengthen the country’s financial position and to support deepening of its financial system without jeopardising its health and stability.