A time series analysis of monetary and fiscal policy interaction: The case of Turkey

Conventional macro economics models imply that inflation is purely monetary phenomenon. According to these models, price level determination is explained via the quantity theory of money and fiscal policy should have no effect upon price level. On the other hand, these models are supported by the Ricardian Equivalence Theorem which implies that as far as consumers have rational expectations, fiscal policy does not have any effects upon aggregate demand and hence it has no effects upon price level and inflation either. The fiscal theory of the price level is a theory asserted against the quantity theory of price level. The main idea of this theory is that fiscal policy effects the price level via wealth effect on the private consumption demand.Fiscal policy matters for the consequences of monetary policy as well. In this study, by estimating fiscal and monetary rule equations via the Markov Regime Switching models, the structures of fiscal and monetary policies are investigated for the Turkish economy for the period of 1989:1-2010:4 in the lights of the theoretical and empirical literature of fiscal theory of the price level.A systematic relation between the policy regime switches of fiscal and monetary policies could not be reached when the results of econometric analysis obtained in this study are evaluated in terms of the monetary-fiscal policy mix. We see that regime switches in monetary and fiscal policy rules do not exhibit any degree of synchronization. The findings of our work suggest that price level determination for the Turkish economy can partly be accounted for by The Fiscal Theory of the Price Level. According to Leeper (1991) terminology, both monetary and fiscal policies may be characterized as the passive ones especially during the crises of 1994, 1998, 2001 and 2008. We find clear evidences that the probabilities of transition from the passive fiscal policy regime to the active fiscal policy regime become higher during the periods before the crises under consideration. The active structure in the fiscal policy until 2001, passivated monetary policy especially at the beginning of the crises, and it lead to the loss of efficiency of the monetary policy. After the crisis of 2001, active fiscal policy structure could not passivate monetary policy and hence more efficient monetary policy could be managed by the Central Bank of the Republic of Turkey.Based on the results mentioned above, the year of 2001 can be considered as a breakthrough in monetary-fiscal policy mix in Turkey.Anahtar Kelimeler: Fiyat Düzeyinin Mali Teorisi, Markov Rejim Değişim Modeli, Para Politikası, Maliye Politikası.