The effect of policy interest rate within the framework of the Turkish inflation targeting

Abstract

In conducting monetary policy under the inflation-targeting framework, the monetary policy stance is signaled through the policy interest rate. Any change in policy interest rate leads first to a change in interest rates on the interbank and latter to change in interest rates of bank credits. The result is a contraction of credit driven aggregate demand and ultimately a weakening of inflation pressures. From the point of view indicated above, this study aims to analyze the effect of interest rate policy on total economic activity within the framework of inflation targeting in Turkey after 2001. In line with this goal, the study investigates the degree and speed of interest rate pass-through from policy rates to retail banking rates by adopting a single equation Error Correction Model for the monthly data over the period from January 2002 to December 2013 in Turkey. By indicating that policy rate has a considerable impact on retail banking rates, empirical findings show that central bank of Turkey has a suitable monetary transmission mechanism in order to use policy interest rate to control credit driven demand and eventually prices in the framework of inflation targeting regime.