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    Do those who talk through their hat know?

    Fatih Özatay, PhD12 September 2010 - Okunma Sayısı: 926


    Let me begin with a quotation from an academic research published in 1995: "There is remarkably little evidence that macroeconomic variables have consistent strong effects on floating exchange rates, except during extraordinary circumstances such as hyperinflations. Such negative findings have led the profession to a certain degree of pessimism vis-à-vis exchange rate research."

    The mentioned macroeconomic variables include inflation, interest rate, current account balance and income level. To put it differently, these are the variables which those consistently talking about exchange rate in Turkey rely on when arguing for the necessity of a certain level of exchange rate. What do these researchers maintain, however? They maintain there is little evidence that there is a correlation between current account deficit or inflation and exchange rate.

    Of course two researchers' saying so does not necessarily make this the case. However there are numerous findings in this direction in the literature of economics. If you take a look at the recent literature on this subject you will immediately notice an explicit confession as to how theories trying to explain how exchange rate is determined fail.

    The following are the introductory lines of the first chapter of a book published in 2001:

    "Ten years ago, a friend of mine who trades spot foreign exchange for a large bank invited me to spend a few days at his side. At the time, I considered myself as an expert, hawing written mu thesis on exchange rates. I thought I had a handle on how it worked" And then continues:

    "I thought wrong. As I sat there, my friend traded furiously, all day long, raking up over $1 billion in trades each day (USD). This was a world where the standard trade was $10 million, and a $q million trade was a 'skinny one'. Despite my belief that exchange rates depend on macroeconomics, only rarely was news of this type his primary concern.

    This book is principally concerned with the gap between what I knew before I sat down with my friend and what I saw when I got there."

    I found it quite interesting, to say the least, that given the apparent failure of theoretical work on how exchange rates are, some people in Turkey make a fuss saying 'exchange rate should stand at this/that level' and criticize critical institutions like the Central Bank in a way that could damage their prestige.

    Exchange rate is a critical variable. It is one of the most important determinants of exports and imports. Since early 1990s, the importance of exchange rate was furthered as a result of the abolition or limitation of constraints on capital movements in a number of countries. And it is an even more important indicator in countries like Turkey, which maintained a long-lasting relationship with the inflation problem. It affects consumption and investment decisions becoming one of the most fundamental determinants of inflation. Therefore, it is commonly addressed in daily talks and debated widely in printed and visual media.

    I will be writing on exchange rate for a while, as far as the national agenda allows.

    Note: The first quotation was from the research of Frenkel and Rose (1995) in Handbook of International Economics Volume III. The other book I quoted from is 'The Microstructure Approach to Exchange Rates' by R. Lyons (2001, MIT Press).


    This commentary was published in Radikal daily on 12.09.2010