Inflation-exchange rate relationship: The case of Turkey

Abstract

The Purpose of the study; transition strategy to the Central Bank's inflation targeting since 2002 in Turkey together is to examine the inflation and exchange rate relations. In this strategy, the most important control instruments of the CBRT are interest rates and exchange rates. Because of Turkey is dependent on imports energy and intermediate goods, the loss of value in exchange rates, causing an increase in producer prices of imported input costs, is creating inflationary effect. The transition effect of exchange rates is partially reflected in domestic prices in countries with low import dependency, whereas in countries with high import dependency in energy and production it is almost completely reflected. In the study, 2003-2017 between years, econometric relationship between inflation and the exchange rate is tested in Turkey. According to ARDL analysis, inflation and exchange rate variables are cointegrated in the long run. The 1 % change in exchange rates increases inflation by 1.13 %, and these variables act together in the long run. Thus, the transition effect appears to be quite high in Turkey during the period mentioned, and the CBRT should take measures to prevent currency depreciation for price stability.