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Measuring Monetary Policy for A Small Open Economy : Turkey

  • Economics


Rogers.dvi Measuring Monetary Policy for A Small Open Economy: Turkey Hakan Berument∗ Department of Economics Bilkent University Ankara, Turkey Phone: + 90 312 266 2529 Fax: + 90 312 266 5140 e-mail: [email protected] February 2002 ∗I would like to thank Anita Akkas¸, Emre Alper, S¸u¨kru¨ Binay, Haluk Erlat, Richard Froyen, Kamuran Malatyalı and participants of seminars at Bog˘azic¸i and Middle East Technical Universities for their helpful comments. Measuring Monetary Policy for A Small Open Economy: Turkey Abstract Empirical research on the effect of monetary policy in open economies faces several abnor- malities like “liquidity puzzle”, “price puzzle” and “exchange rate puzzle”. In this paper, a new monetary policy tool – the spread between the Central Bank’s interbank interest rate and the depreciation of the domestic currency – is introduced to address these three abnormalities within a highly inflationary small open economy setting. A recursive system is used to identify monetary policy shocks and to assess the effect of these shocks on the economy. Our empiri- cal evidence from Turkey suggests that tight monetary policy is associated with a decrease in income and prices and the appreciation of the currency in the short run. For prices and the exchange rate, the effect is permanent; but for income the effect is transitory. Key words: Monetary Policy and Small Open Economy. JEL codes: E50, E52 and E43. 1 Introduction There has been great deal of work on developing monetary models of business cycles. There have also been extensive studies on constructing the empirical measure of exogenous monetary policy shocks. Most of these studies perform their analysis for developed countries (see Christiano, Eichenbaum and Evans, 1999 and references cited therein). However, central bankers of developing countries, while also small and open economies, face additional challenges. Two of these challenges are related: the problem of currency substitution and the centr

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