The effects of monetary policy shocks on macroeconomic variables: A case for Turkish economy

The study analyzes the response of macroeconomic variables to monetary policy and foreign shocks in a small open economy. This study follows Structural Vector Autoregressive model (SVAR) with block exogeneity approach to identify these shocks in Turkey. Some previous studies followed VAR approach (recursive order) to analyze the monetary policy shocks in small open economies but produced price and exchange rate puzzles while using SVAR approach this research does not produce such puzzles. The study uncovers the significance of SVAR approach and reveals that it is a better approach than VAR approach to determine the monetary behaviors in small open economies. This dissertation finds that currency appreciates, and prices diminish in response to tight monetary policy. All results are in accordance with well-known theories. The study discloses that prices are sticky in the short-run. The output increases, but it is not critical. It is not in accordance with theoretical expectations. The interest rate rises as expected in reaction to monetary shock but not significant. The analysis also shows a consistent decrease in the money stock. The contractionary policy helps to increase export and import but only for short term. The research also finds that trade balance initially worsens, and then improves in response to tight monetary policy shock. There is an Inverse J-curve trend in the trade balance. There are some deviations from Uncovered Interest party (UIP) but only for short period. Further, the study displays that foreign output shocks are not critical for domestic economic fluctuations in Turkey except some fluctuations in prices. So, this study tries to find that how much domestic and foreign shocks influence the overall economic conditions in the open economy like Turkey. The study reveals that transmission mechanism works better through the exchange rate.