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Estimating Central Bank Behavior in Emerging Markets: The Case of Turkey

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  • Hatipoglu, Ozan
  • Alper, C. Emre

Abstract

Design of policy rules for an an emerging market central bank (EMCB) operating in an inflation-targeting framework presents additional challenges beyond those for describing the behavior of a central bank in a developed economy. Even though an inflation-targeting regime entails abolishing the exchange rate target in favor of an inflation target, it is more difficult for an EMBC to ignore movements in exchange rates given the relatively shallow depth of financial markets and the the high degree of dollarization. Additionally the EMCB may be forced to change the pursued exchange rate regime following a capital account reversal so that linear Taylor rules may be inadequate for describing EMCB reactions. We develop an empirical framework that addresses these issues and propose a new methodology to estimate unobserved variables such as expected inflation and potential output within the rule. Specifically, we employ a structural, nonlinear Kalman filter algorithm to estimate time-dependent parameters and unobserved variables, and we experiment with various exchange rate mechanisms that can be employed by an EMCB. This approach allows us to track any changes in EMCB behavior - including regime shifts - following a switch to inflation targeting. Using post-2001 data from Turkey, which is a fairly dollarized small open economy, we document that the Central Bank of Turkey has given relatively more importance to the inflation gap than to the output gap or to exchange rates, but not until some time after it had switched to an inflation-targeting framework.

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Bibliographic Info

Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 7107.

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Date of creation: 2007
Date of revision: Jan 2008
Handle: RePEc:pra:mprapa:7107

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Keywords: Dual Extended Kalman Filter; Taylor Rule; inflation targeting; emerging markets;

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  1. Athanasios Orphanides & Simon van Norden, 2004. "The reliability of inflation forecasts based on output gap estimates in real time," Finance and Economics Discussion Series 2004-68, Board of Governors of the Federal Reserve System (U.S.).
  2. Sebastian Edwards, 2006. "The Relationship Between Exchange Rates and Inflation Targeting Revisited," Working Papers Central Bank of Chile 409, Central Bank of Chile.
  3. Engel, Charles & West, Kenneth D., 2003. "Exchange rates and fundamentals," Working Paper Series 0248, European Central Bank.
  4. Hakan Kara & Hande Kucuk Tuger & Umit Ozlale & Burc Tuger & Devrim Yavuz & Eray M. Yucel, 2005. "Exchange Rate Pass-Through in Turkey : Has it Changed and to What Extent?," Working Papers 0504, Research and Monetary Policy Department, Central Bank of the Republic of Turkey.
  5. Cagri Sarikaya & Fethi Ogunc & Dilara Ece & Hakan Kara & Umit Ozlale, 2005. "Estimating Output Gap for the Turkish Economy," Working Papers 0503, Research and Monetary Policy Department, Central Bank of the Republic of Turkey.
  6. Orphanides, Athanasios, 2003. "Monetary policy evaluation with noisy information," Journal of Monetary Economics, Elsevier, vol. 50(3), pages 605-631, April.
  7. Hakan Kara & Fethi Ogunc, 2005. "Exchange Rate Pass-Through in Turkey : It is Slow, but is it Really Low?," Working Papers 0510, Research and Monetary Policy Department, Central Bank of the Republic of Turkey.
  8. Bahmani-Oskooee, Mohsen & Kara, Orhan, 2000. "Exchange rate overshooting in Turkey," Economics Letters, Elsevier, vol. 68(1), pages 89-93, July.
  9. Lawrence J. Christiano & Massimo Rostagno, 2001. "Money Growth Monitoring and the Taylor Rule," NBER Working Papers 8539, National Bureau of Economic Research, Inc.
  10. Mark Aguiar & Gita Gopinath, 2004. "Emerging market business cycles: the cycle is the trend," Working Papers 04-4, Federal Reserve Bank of Boston.
  11. Bernanke, Ben S. & Boivin, Jean, 2003. "Monetary policy in a data-rich environment," Journal of Monetary Economics, Elsevier, vol. 50(3), pages 525-546, April.
  12. M. Ege Yazgan & Hakan Yilmazkuday, 2007. "Monetary policy rules in practice: evidence from Turkey and Israel," Applied Financial Economics, Taylor & Francis Journals, vol. 17(1), pages 1-8.
  13. Akcay, O. Cevdet & Alper, C. Emre & Karasulu, Meral, 1997. "Currency substitution and exchange rate instability: The Turkish case," European Economic Review, Elsevier, vol. 41(3-5), pages 827-835, April.
  14. C. Emre Alper & Ziya Onis, 2001. "Financial Globalization, the Democratic Deficit and Recurrent Crises in Emerging Markets: the Turkish Experience in the Aftermath of Capital Account Liberalization," Working Papers 2001/14, Bogazici University, Department of Economics.
  15. Christopher Allsopp & Amit Kara & Edward Nelson, 2006. "United Kingdom Inflation Targeting and the Exchange Rate," Economic Journal, Royal Economic Society, vol. 116(512), pages F232-F244, 06.
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