Three essays on monetary policy

Monetary policy, which gained importance with the monetarist and new Keynesian economics, is the focus of the studies in the economic literature. Among the hot topics in this area, central bank independence, monetary transmission mechanism and optimal monetary policy are examined in this dissertation as three independent essays by using a wide range of samples and various analysis methods. Chapter Two examines the relationship between inflation, budget balance and central bank independence in both theoretical and empirical frameworks. Following the seminal paper by Acemoglu et al. (2008), a theoretical model and a policy game between the central bank and the government that cover the perfect and imperfect information cases are built. In addition, in order to demonstrate the empirical findings, dynamic panel models with fixed effects are also performed. The findings of the dynamic panel analysis reveal that there is a negative relationship between inflation and central bank independence. The negative impact of central bank independence on inflation is statistically significant and is in line with a priori expectations. When the seesaw and delegation effects are distinguished, the seesaw effect is statistically significant and positive. Acemoglu et al. (2008) explain the seesaw effect as an increase in inflation by a government that wants to monetize the growing budget deficit. The model in which the seesaw and delegation effects are distinguished, on the other hand, shows that a lower budget deficit contributes to lower inflation, consistent with the studies of Sikken and de Haan (1998) and Lucotte (2009). Chapter Three presents how and to what extent the monetary transmission mechanism is successful in Turkey under an inflation-targeting environment. After reviewing carefully the related theoretical and applied literature on monetary theory, the suitable models, i.e., various vector autoregressive (VAR, SVAR, VARX, SVARX) models, are developed for Turkey in the context of a small and open economy. In the baseline and extended vector autoregressive models, the policy interest rate and the narrow monetary base, regarded as a liquidity indicator, are the main drivers of the output level. However, the general price levels are controlled by the changes in real output, liquidity and exchange rate. The policy interest rate, which is implemented by the central bank, and the nominal exchange rate have a significant effect on real output and consumer prices, whereas external variables have a similar, though small, effect, on real output but not on inflation. These results reveal that the CBRT has the ability to influence Turkey's real output level and that monetary transmission is effective. Furthermore, the exchange rate and interest rate channels have a significant effect on the price level. However, the asset price and the liquidity channel are the most important determinants of the real output level. As for the sectoral transmission mechanism, CBRT's policy actions have a statistically and economically significant effect on both the sectoral output level and the sectoral pricing dynamics in Turkey. The exchange rate channel is the key driver of the price level and real output for all sectors, as well as the interest rate channel for the construction sector. Chapter Four focuses on the determination of the optimal monetary policy in Turkey. Following the papers by Gali (2015) and Harrison (2017), a New Keynesian dynamic stochastic general equilibrium (NK-DSGE) model in which Bayesian estimations are included is constructed. Considering all shocks together, Rule 8 and Rule 10, which respond to the exchange rate and output gap deviations, seem the most effective rules to minimize the loss function. Considering all shocks individually, Rule 10 is the most effective monetary rule to minimize the loss function under monetary policy and international interest rate shocks. However, Rule 7, also called the domestic inflation forecast rule, is the most effective monetary rule to minimize the loss function under productivity, preferences and world price level shocks. As to selected variables' impulse responses, Rule 7, Rule 8 and Rule 10 are suitable for explaining the propagation dynamics of the shocks. The posterior probability clearly illustrates that Rule 7 is the best monetary rule to explain the behavior of the variables. Considering all the grounds, Rule 7 looks plausible for Turkey, as an optimal monetary policy. Moreover, CBRT could implement a comprehensive set of monetary rules, such as Rule 8 and Rule 10, against each kind of shock.