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    New era in monetary policy

    Fatih Özatay, PhD16 December 2010 - Okunma Sayısı: 931

     

    Which option should Turkey pursue to overcome the trouble caused by developed countries?

    The latest Financial Stability Report (FCR) by the Central Bank of Turkey (CBT) says: "Developing countries mainly preferred to respond to the surging capital flows with policy tools discouraging capital inflows. In Turkey, different than other developing countries, measures reinforcing financial stability are preferred alongside with the hike in capital flows."

    The report therefore talks about two options as to how to tackle the trouble caused by developed countries. In fact there are three options - that I listed at the end of the commentary. But the report underlines that Turkey (not the CBT alone) preferred the second option.

    Declaration by Mr. Başçı

    The CBT, in the context of this main preference calls economic units for lowering borrowings. Second, the bank aims to establish longer-term liabilities across banks. Third it seeks to ensure that borrowing will be made predominantly in lira terms. All of these are based on the FCR (pages 8-9). In addition, the Bank repeats an important point: It stresses that they implement a monetary policy which pays attention to financial stability alongside with price stability. This is the framework they have established. So we should comment on the declaration by Mr. Erdem Başçı, Deputy Governor of the CBRT, in this framework.

    The CBT does not see any risks with respect to the medium term inflation targets; it believes that it is not necessary to change the policy rate. To secure financial stability on the other hand, rapid credit expansion must be prevented. One way to do this is to raise interest rates significantly in order to reduce credit demand. But in that case interest rate necessary to accomplish financial stability stands considerably above that necessary to secure price stability. So if you decide to raise interest rates to ensure financial stability, you end up adding fuel to flames: you do nothing but reinforce the main reasons of the trouble itself (short term capital inflows).

    Then what should the CBT do? It should activate other tools as well. This is why quantitative restriction has come to agenda. These tools include raising required reserve ratio, asking banks to keep higher rates of reserves for short term liabilities and use the system as a mechanism to discourage FX denominated liabilities. Moreover, borrowing interest rate can be reduced further from 1.75 percent. Nevertheless, it is obvious that there will not provide solution alone as individual measures. Regulation and supervision authority should also step in. Mr. Başçı also underlines that policy rate, which stands at 7 percent currently, will also be reduced.

    I think Mr. Başçı's declaration is quite constructive. What is more, the presentation that accompanied the declaration and accessible at the CBT web site reveals that at the core lies a strong theoretical analysis. You might not agree with this analysis; you might think in a different angle. However, you cannot say 'interest rates are cut upon the pressure by the government' after seeing such analysis.  

    Third option should be chosen
    This policy option is facing two risks. First, quality of fiscal discipline is yet problematic. Second, it may jeopardize the 2011 inflation target in the case of which interest rate cuts will be questioned. So in order to tackle with such critics, the CBT must emphasize repeatedly that we are not living under normal conditions. The importance of financial stability and the role of the CBT in this regard must be highlighted. However, in doing so, the quality of fiscal discipline should also be communicated.

    On the other hand I believe that the preference was lacking some aspects. I think the third option 'all of the above' must be preferred; capital restrictions must be considered.

     

    This commentary was published in Radikal daily on 16.12.2010

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