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Perhaps avoiding multi-objective policies should be the objective
Short-term capital inflows have gradually increased, but exchange rate is not volatile. Real exchange rate has reached 121.
Central banks that implement inflation targeting regimes enjoy a certain advantage. They have only one target to meet: the inflation target. But they focus not only on inflation, but on at least two indicators. On the one hand they try to ensure that inflation is close to the target and on the other hand they try to prevent any possible divergence of growth rate from the potential. Fulfilling the inflation target alone is not enough. They have to keep growth rate in check and reduce the interest rate if it is below the potential, for instance.
I represented this as an “advantage” but I did not tell why. The current monetary policy framework of Turkey better depicts the “why” part of the story, actually. At different points in time, the Central Bank of Turkey declared two numerical targets other than the inflation target: the Bank said that it would respond if real exchange rate index exceeds 120 and that it declared that the desired upper limit for the total credit growth rate was 15 percent. The inflation target was previously released as 5 percent. From time to time, the Bank declared its desire for balanced growth, based equally on domestic demand and foreign demand, maintained that exchange rate volatilities should be avoided; current account deficit should be lowered and accentuated the importance of cutting short-term capital inflows.
So many targets in one basket – some being numerical on top – might get in the way of one another from time to time. Currently, growth performance is below expectations while credit growth rate is around 25 percent, way above the upper limit at 15 percent. Any attempt to limit credit growth might impede GDP growth. Given the circumstances, the CB changes its tune and says, for example, “15 percent was not target but a point of reference. We are flexible on that account.” This is not healthy.
There exists a huge theoretical framework about how to set inflation target, what communication policy to pursue or how to employ policy instruments under inflation targeting regime. A number of economists have made important contributions to the literature during the last three decades. But it is a completely new adventure to set a publicly known credit growth target. We all know that for the sake of financial stability, credit growth should not be high. But there is no significant academic literature and practical information on the issue: what level should be considered high? In what cases does credit growth target conflicts with other monetary policy targets? What is the appropriate communication strategy? Is it the central bank or authorities with macroprudential policy tools – the Banking Regulation and Supervision Agency in Turkey’s case – who should pursue credit growth policies? Which type of credit is to be targeted? We do not know.
Or take the real exchange rate targeting: if a central bank is pursuing an inflation targeting regime, it can design a policy framework which simultaneously seeks to keep inflation rate close to the target, growth rate close to the potential and real exchange rate close to the equilibrium value. But it does not have to announce a real exchange rate target. There are a number of academic studies to refer to on this account. But there are no academic studies on a monetary policy regime that declares numerical targets for inflation rate, real exchange rate and credit growth rate together. There is no model in which non-numerical targets in addition to these three – say reducing exchange rate volatility – are declared, either. There is no knowledge to light the way.
At the point we arrived at, short-term capital inflows have gradually increased, but exchange rate is not volatile. Real exchange rate has reached 121. Savings rate is extremely low. Inflation might prove rigid at 6 percent but growth is weak and export performance is not promising. Yet, credit growth rate is 25 percent!
This commentary was published in Radikal daily on 14.05.2013