The following sentences are retrieved from the second page of the first inflation report published by the Central Bank of the Republic of Turkey (CBRT) in 2010: "The rise in inflation can be attributed to several temporary factors, rather than a deterioration in general price setting behavior. In fact, core inflation indicators in the last quarter point to an underlying inflation trend of around 4 to 5 percent."

The report also gives two graphs on these core indicators which reveal clearly what the main indicators the CBRT focuses on are:  the H and I inflation indicators announced by the TURKSTAT. Another point that is of importance for the theme reflected in the last two commentaries is that the mentioned main indicators exclude the prices of goods and services affected by the changes in tax rates or administrative decisions.

The report of the CBRT goes on as follows: "These observations indicate that the increase in inflation in the last quarter of 2009 is mainly due to temporary developments, and factors beyond the immediate control of monetary policy."

So, what does the bank really say? First, it underlines that the core inflation indicators are in line with the overall trend in the inflation ratio. Second, it maintains that the hike observed in inflation rate over the examined period stemmed from elements out of the influence of the monetary policy.

Similar discourses can also be seen in previous inflation reports. For instance, first page of the report for the first quarter of 2008 reads as follows: "The fall in headline inflation, however, was more limited, owing mainly to factors beyond the control of monetary policy, such as developments in food, energy, and administered prices. Accordingly, inflation was 8.39 percent at the end of 2007, breaching the upper bound of the uncertainty band. Inflation excluding food, energy and tobacco was at 4.8."

So, the Bank refers to one of the core indicators again. The same report says in second and third pages: "changes in the special consumption tax on fuel-oil products, led to a significant rise in prices of fuel-oil products in 2007. Another energy item, housing water prices, which is administered by municipalities, edged up in the last quarter of 2007, partly owing to drought."

"Despite the adverse developments on food and energy prices, the significant deceleration in core inflation set the ground for a relatively less restrictive monetary policy.  Consequently, policy rates were lowered by 200 basis points in the period between September 2007 and January2008."

These citations would be enough. I believe these are striking enough to support my point. So, we can make this inference: If the course of core indicators is in line with the medium term inflation targets, the CBRT does not increase interest rates even they lie above the inflation target calculated on the basis of the CPI. In fact, the Bank can even chose to reduce the interest rate.

But the problem is that inflation realizations stood below the target in all years since 2006, except 2009. And at times the target was revised upwards. Moreover, since2005 inflation rate has been varying between 6 and 11 percent. There exists problem that I have been repeating for a while. First, one element which is believed to have a temporary impact on inflation rate is not so: such as increasing indirect taxes, and raises in tax on directed food prices. We must not exclude these when analyzing core inflation indicators since the practices that push up the prices of the said goods are repeated frequently.

Of course this is not the only problem. A more fundamental problem is that inflation rate calculated on the basis of the CPI does not converge to the inflation calculated on the basis of core indicators; i.e. the fundamental trend in inflation rate. In that case, it is a problem to decide inaction or to decide to cut the interest rate as in the above example on the basis of the core indicator rather than the CPI. I believe that the CBRT needs a new implementation framework. I will continue with this topic.

This commentary was published in Radikal daily on 19.08.2010