I know no academic research stating that current accounts are a tool for monetary policy.

On Thursday I dealt with the recent decision of the Central Bank of the Republic of Turkey (CBRT) in terms of the aspect I supported, which is the fact that the Bank breaks the routine. On Sunday I referred to risks: particularly the absence of a direct limit to short term capital inflows elevates the risk that the decisions will prove ineffective. And today it is time or a critic.

The latest presentations of Deputy Governor Mr.  Erdem Başçı and Governor Mr. Durmuş Yılmaz involve an enlightening figure. It depicts financial stability on the one axis and price stability on the other. It divides the price stability axis in two zones depending on inflation being high and low. Similarly financial stability axis divided into two zones on the basis of rapid or slow credit expansion. Therefore, four zones appear. On this basis the CBRT expresses that interest and non-interest tools such as required reserve ratio will be used depending on zone the economy is located at.

In the zone 1 and 2 characterized with high inflation, interest rates will be pushed up. In case of slow credit expansion non-interest tools will be loosened and in case of rapid credit expansion they will be tightened. In the last two zones with low inflation, interest rate cuts will be pursued. On the other hand non-interest tools will be loosened if credit expansion is slow and tightened if credit expansion is rapid.

Though not involved in the figures, there actually are eight zones in total. In each axis there exists a neutral zone , the zone where everything is on track. If financial stability is not a risk area but inflation is far from the expected level, only the interest rate policy shall be employed (increased or decreased implying two new zones). Or in the opposite case only non-interest tools will be used, adding to new zones to the figure.

In the period where financial stability was not under threat, the world did not go through such severe problems but where individuals were accustomed to living with inflation and adopted behaviors in this line even when the inflation rate goes down with the fear that it can rise back - let's say the period between 2002 and 2005 - it was natural and expected that the CBRT focuses solely on the price stability. And it is also natural that currently financial stability is an equally important concern as the price stability as the circumstances are quite different.

However there exist problems concerning being able to explain what is done or enabling that people acknowledges the meaning of efforts. The presentations and declarations about the motivation of decisions focus too much on the current account deficit problem. It is okay if you stress out loud the importance financial stability along with price stability. The said are the commonly accepted fundamental goals of the central banks. However I know no academic research stating that current accounts are a tool for monetary policy. It is evident that measures initiated to maintain financial stability also works to remedy the current account deficit. It is correct that under the current global circumstances current account deficit might rise even more rapidly, which is an undesired outcome. But the problem is that if in the future current account varies at high levels, say due to high energy prices, while financial stability is sound what will happen if the CBRT is called for duty? You will either express that current account deficit threatens financial stability only in some cases  and thus you might chose not to respond to current account deficit if it does not threaten financial stability, or you will continue your communication strategy putting emphasis only on financial stability rather than current account deficit so that you do not confuse minds or you are not called for irrelevant monetary policy interventions .

This commentary was published in Radikal daily on 27.12.2010