Monetary transmission mechanism in Turkey under the inflation targeting strategy

In Turkish economy monetary policy had supported and financed fiscal policy. After the 2001 Banking Crisis Central Bank of Turkish Republic (CBRT) had become an independent institution and its mission is restricted to maintain price stability. In 2002, CBRT began to pursue implicit inflation targeting strategy, since 2006 it has pursued explicit inflation targeting strategy. The way monetary policy affect price level and output can be understood by monetary transmission mechanisms. Uncovering monetary transmission is vital for choosing policy tools and objectives. Due to fact that CBRT has achieved a disinflation program, which reduces inflation rates to single digit numbers, it is estimated at least one transmission channel operates. This situation causes an emerging interest on which of the channels of monetary transmission operates.Objective of this study is testing the working of monetary transmission channels in Turkey during inflation targeting period and commenting about them considering expectations of economic theories. Sample period begins with January 2002 which the first year of inflation targeting and it ends in February 2010, in which last data is available. Exchange rate, interest rate and credit channels are tested by the Structural VAR methodology.According to Structural VAR results, Exchange rate channel affect both price level and output, interest rate channel affects output rather than its effect on prices and Money supply affects prices stronger than its effect on output. Another finding is that endogenous feature of interest rates.