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    That is what independence is for

    Fatih Özatay, PhD18 July 2013 - Okunma Sayısı: 983

    For the sake of the country it is critical to construct the monetary policy on an exclusively “technical” framework and avoid comments which in some cases press the Bank.

    In periods where significant upswings in exchange rate are observed in Turkey, a diverse array of questions and comments get to be heard. Why does the Central Bank (CBT) sell foreign exchange (FX) at low price? To whom it sells the FX? Why does it deplete its FX reserves so rapidly? When the CBT is supposed to use its reserves if not in times like today? And the list can be extended. The CBT is as often recommended about interest rate decisions. And assume that apart from these, the government “requests” the CBT not to use or refrain from using certain policy tools.

    Evidently, all these comments make a huge “noise” which makes it difficult to think clearly. What you need in such periods it to not panic and think straight. Moreover, for the sake of the country it is critical to construct the monetary policy on an exclusively “technical” framework and avoid comments which in some cases press the bank. That is what central bank independence is for.

    At this point it would be useful to recall the concept of independence. For the purposes of this commentary, two types of independence are critical: objective independence and instrument independence. If the central bank is free in setting its objective, than it has objective independence. This clearly is not democratic. After all, the government of an elected parliament has to have the authority to set the objectives of the central bank, which operates as per the law again enacted also by the elected parliament. If the central bankers do not approve the objective, they can always resign! Instrument independence means that central banks have the freedom and authority to decide which policy tools (required reserve ratio, interest rate, exchange rate interventions etc.) to employ. Monetary policy making is a technical task. If the central bank fails in achieving its targets, the government calls the bank to account. Central banks are accountable also to public. Instrument independence is democratic and beneficial since it helps central banks to resist the pressure that might come from different circles as I mentioned above. Of course it is not enough to secure instrument independence by law. The central bank has to know its value as well.

    To say a few words on the CBT, this is what I see when I look at the issue from a solely “technical” perspective: if the unfavorable situation in financial markets is temporary and if things are to settle down in not more than a few months, interest rate will fall back and the lira will start appreciating. If the interest rate that increased from 4.5 percent to 9.5 percent in the last two months and that now floats around 9 percent will soon fall back to 4.5 percent level why would the CBT bother increasing the rate? Instead, it would make a credible statement explaining why the unfavorable situation is temporary and would avoid sharp moves so as to contribute to the reliability. If the Bank is of the view that the current movement is temporary, it does not need to carry out extensive FX sales, either. It just has to let the exchange rate increase since it will in time fall back automatically.

    If the unfavorable outlook will prevail for quite a long time, the Bank has to use the interest rate instrument. Since, should rates will remain high for a considerably long timeframe, refraining from increasing the policy rate would exacerbate risks, further increasing the market rate. The reason is quite evident: why would a foreign investor risk investing in a country which fails to give economic policy responses when needed?

    So, I am back to the square one: will the tension in financial markets we have witnessed in the last two months and the resultant interest and exchange rate movements vanish soon or prevail for a couple of years with ups and downs? The statement Bernanke is to make today is of importance for the answer. It will also give the CBT an opportunity to reassess the general state of affairs.

    This commentary was published in Radikal daily on 18.07.2013