There are several ways to harmonize the policy tool devoted to ensure financial stability and to ensure price stability.

Now it’s finally time for the last commentary of the series. Here is how I concluded on Tuesday: “The policy rate is a strong tool as long as it can affect the market interest rate. The way to affect the market rate, however, is to ensure that the short term market interest rate and the policy rate stand close to each other. However, the CBT has been allowing the former deviate continuously from the latter, in different directions and magnitudes. In a nutshell, in order to ensure that the macro-prudential tool serves its purpose, the CBT is allowing the policy rate lose its influence as a policy tool. How can the two tools work harmoniously?”

We have “partial” results concerning the answer to this question: In June 2011, the Banking Regulation and Supervision Agency (BRSA) introduced a set of decisions about reserves banks are required to keep for certain types of credits. Following these, pace of growth of credit supply slowed down considerably. I said we had “partial” results and this is why: Yes, the pace of credit growth slowed down following the BRSA’s intervention. However, two months after the decision, the Eurozone has gone into a chaos and risk appetite has decreased, which might be another reason for the slowdown in credit supply. When you cannot make a controlled experiment, you have to doubt which factor exactly the result stemmed from. But let us cast away doubts and accept that the mentioned decisions by the BRSA have had a role in the slowdown of credit supply.

There are several ways to harmonize the policy tool devoted to ensure financial stability and to ensure price stability. The first two of the options are derived from the experiment I mentioned above: Turkey can take steps to strengthen the classical inflation targeting regime that overall gave fruitful results in tackling inflation between 2002 and 2010. To this end, certain powers of the BRSA can be transferred to the CBT. In that case, problems might arise about harmonizing the capital requirements set for each bank by the BRSA and the general capital adequacy requirements set by the CBT. But these problems can be overcome via additional regulations. A more radical option is to incorporate the BRSA and the CBT, which is already the case in some countries.

A third option is to preserve and strengthen the status quo. In this context, the BRSA and the CBT to take joint decisions can be considered as an option. Under this scenario, there are question to be tackled: Whose policy recommendation shall be applicable? What shall be done if agreement is reached only on an interim option? Who shall be responsible for ensuring coordination between the two institutions? The government, for instance? Under the current institutional framework, such an attempt might risk the “independence of the CBRT” and the autonomy of the BRSA. The first two options, however, do not incur such risk.

This commentary was published in Radikal daily on 02.02.2012