SPILLOVER EFFECTS OF US MONETARY POLICY ON INFLATION RATE AND FX VOLATILITY IN TURKEY: A VECM ANALYSIS

We aim to examine the effectiveness of the Central Bank of the Republic of Turkey’s (CBRT) monetary policy tools in reducing inflation and exchange-rate volatility, given the spillovers emanating from the Federal Reserve’s (FED) policies between 2010 and 2022. Relying upon the vector error correction model methodology proposed by Johansen (1995), we found that the inflation rate, one of the main indicators of internal equilibrium conditions, is affected more strongly by global liquidity conditions than by the CBRT’s policies. Moreover, the evidence suggests that the long-term US interest rate proves to be the most disturbing factor to the exchange rate volatility in Turkey. More particularly, we show that the destabilizing effects of increases in the long-term US rates are stronger than the ability of the CBRT’s contractionary policies to fix internal and external disequilibria, which is evident of the erosion in the CBRT’s credibility. Given the devastatingly high economic and social costs associated with these rate hikes, the CBRT may instead turn to ways for enhancing the effectiveness of its policy tools by abandoning its unconventional policies. In this regard, it may start with restoring its highly damaged credibility and introducing some regulations restricting the free capital mobility.