Mitigating Turkey’s Trilemma Tradeoffs

We study the trilemma configuration of the Turkish economy for the period 2002–11. This includes calculating the trilemma indices and regressing them on a constant following Aizenman et al. (2008). Yet we extend this approach by applying a Kalman filter to the classical linear regression to capture the time-varying importance of policy decisions. Next, we reveal the role of central bank foreign reserves and required reserves in mitigating trilemma tradeoffs through their relation with trilemma residuals in a vector autoregression (VAR) framework—we show that the foreign reserves to GDP ratio and the required reserve ratio have a positive significant impact on the residuals, thus making the policy tradeoffs smaller.