Roles of the Government Bond Yield and the Exchange Rate in the Monetary Conditions of Türkiye

Abstract

The debate over measuring central bank monetary policy stance persists in the literature. Evolving economic dynamics and diverse economic structures render traditional metrics inadequate, prompting the development of comprehensive monetary conditions indexes. In this respect, this study aims to craft a novel monetary conditions index for Türkiye, discovering an important yet neglected tool. This index consists of the real effective exchange rate and a spread that is the difference between the Central Bank weighted cost of funding rate and the benchmark bond yield. The weights of the exchange rate and spread in the index were determined using a VAR model and variance decomposition analysis. According to these weights, we created the monetary conditions index and tested its impact on the prices throughtheGrangercausalityanalysis.Theresultsindicatethatourmonetary conditions index significantly affects the prices in Türkiye, which proves the role of the government bond yield in the monetary transmission. It is further found that the exchange rate has a direct impact on the inflation rate and responds significantly to changes in the spread, implying that the spread influences prices primarily through the exchange rate pass-through mechanism.

Keywords

• Monetary conditions
• fiscal policy
• bond yield
• exchange rate
• inflation

References

1. Berument, H. (2007). Measuring policy for a small open economy: Türkiye. Journal of Macroeconomics, 29(2), 411-430. google scholar
2. Brooks, P. K. (2007). The bank lending channel of monetary transmission: Does it work in Türkiye? (No. 7-272). International Monetary Fund. google scholar
3. Curdia, V. and Woodford, M. (2010). Credit Spreads and monetary policy. Journal of Money, Credit and Banking, 42, 3-35. google scholar
4. Çebi, C. (2012). The interaction between monetary and fiscal policies in Turkey: An estimated New Keynesian DSGE model. Economic Modelling, 29(4), 1258-1267. google scholar
5. Debuque-Gonzales, M., and Gochoco-Bautista, M. S. (2017). Financial conditions indexes and monetary policy in Asia. Asian Economic Papers, 16(2), 83-117. google scholar
6. D’Amato, L. and Garegnani, M. L. (2009). Studying the short-run dynamics of inflation: Estimating a hybrid new-keynesian Phillips Curve for Argentina (1993-2007) (No. 2009/40). Working Paper. google scholar
7. Ericsson, N. R., Jansen, E. S., Kerbeshian, N. A., and Nymoen, R. (1997, November). Understanding a monetary conditions index. In November 1997 meeting of the Canadian Macroeconomic Study Group in Toronto. google scholar
8. Eroglu, I. (2018). Inflation and the Determinants of Growth in Türkiye. Journal of Economics, Management and Trade, 1-12. google scholar

9. Freedman, C. (1994). The Use of Indicators and of the Monetary Conditions Index in Canada. In Balino, T.J.T. and Cottarelli, C. (eds), Frameworks for Monetary Stability: Policy Issues and Country Experiences, 458-476, IMF, Washington, D.C. google scholar
10. Goodhart, C., and Hofmann, B. (2001, March). Asset prices, financial conditions, and the transmission of monetary policy. In conference on Asset Prices, Exchange Rates, and Monetary Policy, Stanford University (pp. 2-3). google scholar
11. Gujarati, D. N. (2010). Essentials of Econometrics. New York: McGraw-Hill. Fourth edition. google scholar
12. Gürkaynak, R. S., Levin, A. T. and Swanson, E. T. (2006). Does inflation targeting anchor long-run inflation expectations? Evidence from long-term bond yields in the US, UK and Sweden. CEPR Discussion Paper No. 5808 google scholar
13. Hatzius, J., Hooper, P., Mishkin, F. S., Schoenholtz, K. L. and Watson, M. W. (2010). Financial conditions indexes: A fresh look after the financial crisis (No. w16150). National Bureau of Economic Research. google scholar
14. Hyder, Z. and Khan, M. M. (2006). Monetary conditions index for Pakistan. Karachi: State Bank of Pakistan. google scholar
15. Johansen, S. (1991), Estimation and hypothesis testing of cointegration vectors in Gaussian vector autoregressive models, Econometrica: Journal ofthe Econometric Society, 59(6) 1551-1580. google scholar
16. Johansen, S. and Juselius, K. (1990), Maximum likelihood estimation and inference on cointegration with applications to the demand for money, google scholar
17. Oxford Bulletin of Economics and Statistics, 52(2), 69-210 google scholar
18. Juhro, S. M., and Njindan Iyke, B. (2019). Monetary policy and financial conditions in Indonesia. Bulletin of Monetary Economics and Banking, 21(3), 283-302. google scholar
19. Kara, A. H., Ozlu, P. and Unalmis, D. (2012). Financial conditions indices for the Turkish economy (No. 1231). Research and Monetary Policy Department, Central Bank of the Republic of Türkiye. google scholar
20. Karaoğlu, N., and Demirel, B. (2021). Asymmetric Exchange Rate Pass-Through into Inflation in Turkey: A NARDL Approach. Fiscaoeconomia, 5(3), 845-861. google scholar
21. Kesriyeli, M., and Kocaker, I. I. (1999). Monetary conditions index: A monetary policy indicator for Türkiye. Central Bank of the Republic of Türkiye, Research Department. google scholar
22. Lütkepohl, H. (2005). A new introduction to multiple time series analysis. Springer Science and Business Media. google scholar
23. Memon, I. A., and Jabeen, H. (2018). Monetary condition index and its changing transmission on macro-economic variables. Arab Economic and Business Journal, 13(2), 111-124. google scholar
24. Mihaljek, D. and Klau, M. (2008). Exchange rate pass-through in emerging market economies: what has changed and why? BIS Papers, 35, 103-130. google scholar
25. Nucu, A. E. and Anton, S. G. (2018). Monetary Conditions Index: New Empirical Evidence from Central and Eastern European Countries. Ekonomicky Casopis, 66(2), 139-158. google scholar
26. Peng, W. and Leung, F. (2005). A monetary conditions index for Mainland China. Hong Kong Monetary Authority Quarterly Bulletin, 6, 5-14. google scholar
27. Qayyum, A. (2002). Monetary conditions index: A composite measure of monetary policy in Pakistan. The Pakistan Development Review, 551-566. google scholar
28. Sims, C.A. (1980). Macroeconomics and reality. Econometrica: Journal of the Econometric Society, pp.1-48. google scholar
29. Taylor, J. B. (1993). Discretion versus policy rules in practice. In Carnegie-Rochester conference series on public policy (Vol. 39, pp. 195-214). North-Holland. google scholar
30. Us, V. (2004). Monetary transmission mechanism in Türkiye under the monetary conditions index: an alternative policy rule. Applied Economics, 36(9), 967-976. google scholar
31. Zhu, S., Kavanagh, E., and O’Sullivan, N. (2021). Inflation targeting and financial conditions: UK monetary policy during the great moderation and financial crisis. Journal of Financial Stability, 53, 100834. google scholar