Implicit asymmetric exchange rate peg under inflation targeting regimes: the case of Turkey

Especially after the 2000s, many developing countries let exchange rates float and began implementing inflation targeting (IT) regimes based on mainly manipulation of expectations and aggregate demand. However, most developing countries implementing IT regimes experienced considerable appreciation trends in their currencies. Might have exchange rates been utilised as implicit tools even under IT regimes in developing countries? To answer this question and investigate the determinants of inflation under an IT regime, as a case study, this article analyses the Turkish experience with IT between 2002 and 2008. There are two main findings. First, the evidence from a vector autoregressive (VAR) model suggests that the main determinants of inflation in Turkey during this period are supply-side factors, such as international commodity prices and the variation in exchange rate, rather than demand-side factors. Since the Turkish lira (TL) was considerably over-appreciated during this period, it is apparent that the Turkish Central Bank benefited from the appreciation of the TL in its fight against inflation during this period. Second, our findings suggest that the appreciation of the TL is related to the deliberate asymmetric policy stance of the bank with respect to the exchange rate. Both the econometric analysis from a VAR model and descriptive statistics indicate that appreciation of the TL was tolerated during the period under investigation, whereas depreciation was responded aggressively by the bank. We call this policy stance under IT regimes ‘implicit asymmetric exchange rate peg’. The Turkish experience indicates that as opposed to the rhetoric of central banks in developing countries, IT developing countries may have an asymmetric stance towards exchange rates and favour appreciation of their currencies to hit their inflation targets. In this sense, IT seems to contribute to the ignorance of dangers regarding over-appreciation of currencies in developing countries.