The effectiveness of exchange rate of inflation targeting interventions: The case of Turkey

Inflation targeting regime is to emphasize the primary objective of monetary policy is to maintain a low and stable inflation rate and its being adopted by monetary authority. Central Bank of Republic of Turkey (CBRT) adopted `Implicit Inflation Targeting? between the years 2002 and 2005 and has been performing `Explicit Inflation Targeting Regime? since the beginning of 2006. It is seen that inflation targeting regime is being applied along with flexible exchange rate system and in this stated regime, central banks intervene in foreign exchange market with the purpose of smoothing the excessive exchange rate fluctuations. Concordantly, in this study it is aimed to detect the efficiency of CBRT?s indirect purchase and sale interventions in foreign exchange market during the period between January, 2006 when Turkey started to adopt explicit inflation targeting regime and August, 2012. In general, GARCH models are preferred for modeling the volatility in financial time series. In consequence of diagnostic tests in this study, T-GARCH (1,1) model is specified as the most appropriate model which also allows using dummy variable. According to the empirical findings of this study, the CBRT?s purchase and sale interventions in foreign exchange market don?t have a significant effect on the mean exchange rate returns. Regarding volatility, both of the purchase and sale interventions cause the exchange rate volatility to increase, but only the purchase interventions have a significant effect on the volatility in the statistical sense. In addition, it is found that negative shocks have larger effect on the volatility than positive shocks, i.e., the leverage effect exists. Key Words: Exchange Rate, Exchange Rate Systems, Inflation Targeting, Open Economy Inflation Targeting, Central Bank of Turkey, Interest Rate Corridor, Reserve Option, Time Series, ARCH/GARCH Models, T-GARCH Model