The effect of financial frictions on monetary shocks in Turkey

Financial frictions arise from factors such as information asymmetries, collateral constraints, and agency problems, and they generate not only micro-level distortions but also significant macroeconomic effects on credit supply, investment decisions, and aggregate demand. In the post-crisis period, the Central Bank of the Republic of Turkey (CBRT) has adopted financial stability as a policy objective; however, this approach does not offer a policy framework that directly incorporates financial frictions. This study investigates the effects of financial frictions on monetary policy in Turkey within the framework of a New Keynesian Dynamic Stochastic General Equilibrium (DSGE) model. Following the 2008 global financial crisis, financial frictions have regained importance in the economics literature, leading to a renewed need to restructure traditional macroeconomic models to more accurately reflect the interaction between the real economy and the financial system. In this context, the study analyzes the interaction between financial frictions and monetary policy in Turkey using a DSGE model developed by Gertler and Karadi (2011), which is based on agency problems in the banking sector. The model is extended to reflect the specific economic characteristics of Turkey and is estimated using Bayesian methods. The findings reveal that shocks originating from the financial system exert persistent downward pressure on investment, consumption, and output, while monetary policy tends to respond to these shocks in a limited and delayed manner. In contrast, external interest rate shocks are transmitted more quickly and broadly through the credit channel when financial frictions are present. This indicates that monetary policy should be responsive not only to interest rates but also to broader financial conditions. The study shows that the classical Taylor rule overlooks financial vulnerabilities and suggests that a policy rule extended with indicators such as the credit spread allows for earlier and more effective interventions against financial shocks. Consequently, the existence of financial frictions clearly highlights the necessity of a more proactive and multidimensional monetary policy framework in Turkey. In this regard, the study provides significant contributions to both academic literature and the monetary policy design process.