Monetary policy is founded on two pillars. Interest rate decisions are made by the MPC, required reserve ratio is set by the General Assembly.

Yesterday the Central Bank of Turkey (CBT) has announced the decision on the required reserve ratio. As was also stated before, the ratio was raised for the short term liabilities of banks and kept for the long term liabilities.

The CBT thinks that the current circumstances are quite different than those in the 2003-2007 period and believed that the said circumstances, high level of short term capital inflows in particular, threatens financial stability. Therefore, different than the past it draws attention to two separate objectives. It highlights both "price stability" and "financial stability" addressed in the Bank's law.

The Bank maintains that since the current circumstances are distinct, the policies to be adopted so forth will also be different. The bank does and aims to reduce the interest rate as long as it is consistent with the inflation target. On the other hand, it will ease the credit expansion using non-interest policy tools. In short, we are faced with a new monetary policy framework. 

The Central Bank chooses the instrument
This new situation gives way to a non-anticipated problem. The CBT Law was amended substantially on April 25, 2001. The new Law allowed the CBT to use any monetary policy instrument at its disposal in line with the targets set in cooperation with the government. This decision constitutes an important part of the CBT's independence. In parallel with the international practice, the Law also introduced other amendments tailored to reinforce Bank's independence. Method of assignment for the governor and the vice governor was changed. Term of office was extended from three to five years for vice governors. Monetary Policy Committee (MPC) was established to take monetary policy decisions. As a joint stock company, in the organization chart of the CBT there also exists a General Assembly (GA) that generally takes administrative decisions. This body has authorities about monetary policy, too. For instance it is the GA, not the MPC authorized to change the required reserve ratio. Most probably, when the law was being amended, it was thought that the required reserve ratio would not be used actively as a monetary policy instrument and thus the authority to change it was not given to the MPC. The MPC is composed of seven people: the chair, four deputy chairs, one GA member and a member assigned by the government. All members but the GA member stay at office for five years.  The GA is composed of seven people: the chair and six members. All but the chair stay at the office for three years; two members change in each year.

As the new law stipulates the Governor of the CBT is assigned by the Council of Ministers. Vice governors and the MPC member of the government are assigned with a tripartite order upon the advice of the Governor. However, GA members are decided by the Treasury, the largest shareholder of the CBT (members are legally elected in the general board of the company).

Let us put aside and absolve the officials currently holding the said positions and assess the institutional structure only: The MBC is an independent body in compliance with the modern central banking criteria. On the other hand, the GA is composed of the representatives of shareholders in line with the criteria that apply for a joint stock company. It is dependent by nature. This is why the method of assignment of the members and the terms in the office are different. And this is why I have addressed the issue here.

The new CBT policy caused problems in this regard. Monetary policy is now founded on two pillars. Decisions on the interest rate pillar are made by the MPC that is legally independent. Decisions in the second pillar such as required reserve ratio decisions are made by the General Assembly. The CBT Law must be amended due to this reason, let alone the incoordination that might appear between these two bodies in a normal time.

This commentary was published in Radikal daily on 25.01.2011