A review on currency shocks and inflation volatility: Evidence from a DCC-GARCH model

In the present research, the relationship among the exchange rate and inflation in Turkey was investigated by considering the monthly dataset among 1990:1-2022:4 years. The consumer price index, producer price index, industrial production index, nominal exchange rate, and money supply are used as variables to represent inflation. Impulse-Response analyzes were used to find the short-term effects of the variables, decomposition of variance analysis for the causes of the changes in the variances of the variables, and the medium and long-term relationships of the variables in pairs were determined by DCC-GARCH models. While the models were being created, they were seasonally adjusted, and the inputs of the DCC-GARCH models were determined, consequently, the VAR analysis. In the results of the impulse-response analysis, it is seen that the reaction of inflation to the exchange rate shock is positive and lasts for five periods, after which the response fades. In the results of the impact-response analysis of the exchange rate, it has been determined that the reaction of the exchange rate to inflation has been stable for twelve periods. In the results of the variance decomposition analysis for inflation, at the end of twelve periods, 4.83% of the change in inflation was caused by the exchange rate; In the exchange rate variance decomposition analysis, it was concluded that 8% of the difference in the exchange rate was caused by inflation. While GARCH models show a negative interaction between inflation and exchange rate, DCC-GARCH results show that the permanence degree of short-term shocks between inflation and exchange rate is 0.43%. In addition, while a semi-strong GARCH process was found between inflation and money supply, a strong GARCH process was found between inflation and producer price index.