Central bank monetary policy reaction function: An emprical analysis for Turkey (1990-2003)

A monetary policy rule is a guideline for a monetary policy maker to adjust monetaryinstruments to reach policy goals, like a stable inflation rate. In this context, a policy rulecould be seen as a set of central bank policy reaction functions.Optimal policy rules can be based on complex models. But complex models will notlikely solve the problems of discretionary policy. Because all the information which neededfor the complex rule can not be checked by public. Simple rules, like the Taylor rule is easierto understand and to apply. But exchange rate is not considered by Taylor rule which isclosely followed by the economic agents. This study extends Taylor rule by including theexchange rate in the model.The purpose of this study is to examine The Central Bank of Turkey?s monetary policyreaction function by extending Taylor rule and applying the VAR model over the period1990: 1-2003: 4. For this aim the Central Bank?s monetary policy reaction function have beenestimated to measure the performance of monetary policy and evaluate the relationshipbetween monetary policy and macroeconomic variables. According the results, the overnightrate has a negative and unsignificiant response to shock of the output gap, the inflation gap,the exchange rate or lagged overnight rate. These outcomes show that as a monetary policyinstrument, short term interest rate is not expected to be sufficiently effected to ensure thestability of price and output in Turkey who has a chronic inflation for a long period of time.Hence, in order to reach the monetary policy goals and the usage of short term interest rate asa policy tool, the public debt and the borrowing requirement should be reduced, financialsystem should be developed and the inflation rate should be brought down to moderate levels.