Investigation of Taylor Rule in the framework of Central Bank interest theory

It has been discussed for a long time if the monetary policy depends on discretion or policy rules. Although it is accepted that monetary policy should be applied within the scope of a rule, consensus has not been reached about which monetary rule should be applied. However it is stated that clearance of applied rule and its understandability by economics agent are effective and supportive for the monetary policy. In this study, Taylor Rule, a recommendation of a monetary policy rule, which is clearance and understandability by economics agents is tested in terms of its validity. In this way, it is an estimated retrospective monetary policy reaction function for Turkey. Since Classic Taylor Rule does not contain exchange rate, this model is generated by adding exchange rate to the model. Generated reaction function is estimated by using monthly date between 2002:07 – 2013:11. Thus, the relationship between variables has been interpreted in this term. As a result of estimated reaction function, it is determined that the response of the short run interest rate to a shock - in production gap, inflation gap or exchange rate - that may occur is not statistically significant among specified terms. In accordance with the results obtained, short run interest rates are not enough to provide steady and stable inflation and growth rate. In order for short run interest rate to response statistically significant, primarily, the amount of debt of the public sector should be reduced. Additionally, it is proposed that funded practices of public debt should be revised to executors of the fiscal policy. Keywords: Taylor Rule, Interest Reaction Function, VAR Model