An Empirical Analysis of Inflation Targeting in Dual Banking System: Case Study of Turkey.

Abstract

Inflation has many important macroeconomic issues in many countries like Turkey. The uncertainty resulting from high inflation is one of the negativities that closely affect the financial sector. The purpose of this paper is to explore the feasibility of inflation targeting monetary policy in the dual banking system. The study investigates the long-run relationship between inflation rate, interest rate, real effective exchange rate, narrow money, and profit rate. The data collected were monthly and the period is from 2007 to 2017. The result of the study showed that interest rate and narrow money have a positive correlation with the inflation rate. Inflation targeting may not be a proper monetary policy for the financial system of Turkey. Because of the high sensitivity, it is not always easy to achieve targeted inflation. Instead of inflation targeting, interest rate targeting may help monetary policies to exert more influence on the financial sector. Keeping the interest rate under control may be a more useful monetary policy. In this way, the effects of monetary policies will be reflected more directly in the financial sector. If the monetary policies implemented are become more effective for both types of finance, their contribution to the economy will be enhanced, and controlling the macroeconomic targets will be more easily fulfilled. Thus, controlling the interest rate will give the authorities more control over Islamic finance in the sector.

Keywords

• Dual banking
• Islamic finance
• Inflation
• Interest rate
• Inflation targeting

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