Effectiveness of Inflation Targeting: Turkey's Experience

This report delves into the effectiveness of inflation targeting as a monetary policy tool, exploring its definition, tools (interest rates, reserve requirements, and open market transactions), and characteristics, such as central bank independence, credibility, and transparency. It outlines the prerequisites for successful implementation, including central bank independence, economic stability, and advanced infrastructure. The report then examines the reasons countries adopt inflation targeting and assesses its effectiveness in developing economies, using Turkey's experience from 2002 to 2020 as a case study. The analysis covers Turkey's monetary policy during this period, identifies main challenges, and evaluates the impact of inflation targeting. Finally, the report draws lessons and concludes by summarizing the findings and their implications for economic policy.

The Effectiveness of the Inflation Targeting Policy1
THE EFFECTIVENESS OF THE INFLATION TARGETING POLICY
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The Effectiveness of the Inflation Targeting Policy2
Contents
Introduction.................................................................................................................................................4
MAIN BODY..............................................................................................................................................5
CONCLUSION.........................................................................................................................................22
REFERENCES..............................................................................................................................................24

The Effectiveness of the Inflation Targeting Policy3
THE EFFECTIVENESS OF THE INFLATION TARGETING POLICY
Abstract
This study serves to document the effectiveness of employing inflation targeting as a
monetary policy and link it how these policies work hand in hand with economic institutions
which underwent a series of reforms to improve growth following Turkey’s financial crisis in
2001. The reversal in institutions is as a direct effect of the political turnaround. The first
political turnaround coincided with an in-depth deepening in the democratic levels in Turkey
under the tutorage and guidance of the European Union. Coupled with a series of policies to
recover the economic strength, we focus on how inflation targeting policy helped in stabilizing
the economy and how effective it is to economic growth. Faced with several challenges and
obstacles, we delve into how the adaption of inflation targeting has been effective in developing
economies, with emphasis on Turkey as our case study.

The Effectiveness of the Inflation Targeting Policy4
INTRODUCTION
According to EserTurer, Inflation targeting refers to an act by the monetary control
authority, central banks specifically, to regulate the general prices of goods and services. In an
attempt to control prices by the Central banks, policies are coined and enacted such that actual
inflation is measured against a hypothesized inflation rate using such avenues as manipulating
the interest rates (Agénor&da Silva, 2019). The hypothesized inflation, recognized as a projected
inflation rate, is spelled out, and its enactment is made known to the public. Inflation targeting
policies take effect and are distinguished because of the imminent opposite movement of the two
monetary rates; interest rates, and inflation rates. The parallel movement of the interest rates and
the Inflation rates are probable drivers of the country's growth extent. This view of inflation
targeting as control for price of goods and services is however insufficient in its definition.
Unlike what Eser suggests, inflation targeting should not only concerned with the manipulation
of the prices, rather, inflation targeting is a broad concept about the general implication of the
monetary policy on the macroeconomic front of country’s that enact the policy. Significantly,
inflation targeting with an emphasis on pricing does not affect other microeconomic objective
like reaching a stable real economy or a competitive exchange rate.
Edwin Truman proposes that inflation targeting is a strategy by the central banks to
specify an inflation rate aw a goal and to adjust the monetary policies to adjust to such
goals(Aguir, 2018, pg.93). This definition of inflation targeting focusses on the maintenance of
price stability. Economic stabilization generally left on hands of the central bank. However, this
view of inflation as a function of the central bank to control price stability disregards the
international monetary fund’s own input in monetary control especially in the emerging
economies.

The Effectiveness of the Inflation Targeting Policy5
Inflation Targeting Policy refers to a Central Bank Strategy in which a specific inflation rate is
set as a goal and the different types of adjustments are done in the monetary policy so that the
goal can be attained effectively and efficiently. Thus, In this way it can be said that the use of
this particular policy will be helpful in ensuring that the attainment of economic goals and
objectives in the future can be done. This can help in improving the economic situation within a
country and can help in targeting a higher-level of economic growth in the future. Therefore, it
becomes highly important for the Central Banks that they are able to take appropriate decisions
regarding the use of this policy which will be helpful in ensuring that the economic growth can
be enhanced in the future. Thus the economists have to contribute to the best of their abilities so
that they are able to ensure that the use of this policy can be made in a right manner. The various
types of tools which are used for the purpose of Inflation Targeting are Interest Rates, Reserve
Requirements and Open-Market Transactions. Thus, in this way it can be said that the use of ITP
can be done so that the use of these tools can be made in order to control the rate of inflation
which is prevailing in the economy. In this report, specific focus will be put on the effectiveness
of ITP. Additionally, a detailed discussion on Evaluation of the Turkish Experiment from 2002
to 2020 will be made as a part of this assignment.
MAIN BODY
Kenneth proposes that inflation targeting is described as a monetary control tool. The
central bank formulates a short-range inflation target and declares such targets of inflation to the
public to spearhead a country's economic growth and stability (Bernanke & Mishkin, 1997).
Several explanations are given for inflation targeting and its practicality. Kenneth, for example,
justifies inflation as a management framework rather than a mere rule of inflation control.
According to Kenneth, inflation targeting is a justifiable framework to objectively spearhead

The Effectiveness of the Inflation Targeting Policy6
growth through a policy rule of management in a macroeconomic environment. Kenneth fails to
recognize the importance of a wholesome view of inflation targeting as both a rule for attaining a
target inflation and a means or framework for such inflation targeting purposes.
According to Svensson, inflation targeting can be termed as flexible inflation targeting or
as simply forecast targeting. Svensson argues that inflation targeting refers to formulating a
policy rate and a policy rate path which have the advantage of making the inflation and
employment forecast appear satisfactory of looking good (Svensson, 2020). Forecasts targeting
can also mean formulating and publishing a policy target path and the forecast of both inflation
and employment, and most importantly, amplification and justifying such forecasts(Adler, Lama
and Medina, 2019).
Inflation Targeting Tools
There main tools used for inflation targeting are: interest rates, open market transactions, and
reserve requirements. The reserve requirement can be used to influence inflation targeting by
enacting a decrease in the cash on hand for the commercial banks through the central bank.
Eventually, the banks will increase the number of loans advanced to the public increasing money
supply and investment responsible for economic growth and stability(Ardakani, Kishor and
Song, 2018). On the other hand, open markets refer to the enactment of such short-term interest
rates, which are periodically changed to suit the target inflation rate at a specified interest range.
i) Interest rates- interest rates set by the central bank influences inflation. Lower interest
rates increase inflation while higher interest rates are deflationary.

The Effectiveness of the Inflation Targeting Policy7
ii) Reserve requirements- changes in reserve requirements on deposits are used to
control the number of loans in the economic system, which has effects on consumer
purchase and, eventually inflation.
iii) Open-market transactions- this phenomenon enhances openness, credibility, and
accountability in market transactions.The use of ITP here can be helpful because it
will bring transparency in the process of making the use of this tool in order to control
the rate of inflation which is prevailing in the market so that the higher-level of
economic growth can be targeted in the future.
Characteristics of inflation targeting policy
The central bank must possessthree main characteristics to ensure a successful pursuit of its i1.
1.Central bank independence
If central banks are not independent, monetary policies may be influenced by short-term
political interests that can be inconsistent with the inflation goals. For example, politicians may
try to stimulate the economy with several monetary tools hoping for reelection, which can lead to
higher inflation and failure in reaching the inflation targets previously set.
2. Central bank’s credibility
In some cases, inflation targets may be inconsistent with other macroeconomic
conditions. For example, a heavily indebted country that is aiming for a very low level of
inflation may not be credible, as it could be in the government’s interest to resort to a higher
inflation rate to dilute the real value of debt.
3. Central bank’s transparency

The Effectiveness of the Inflation Targeting Policy8
The concept of transparency is connected to that of credibility. A central bank that is not
transparent in its decisions will ultimately lose credibility. That’s why many central banks
produce quarterly reports, where they discuss the state of the economy and the trends in
variables, such as money supply, securities markets, gross domestic product (GDP),
employment, and prices(Buffie, Airaudo and Zanna, 2018).
4.Self-fulfillment of inflation-targeting policies
In some cases, inflation targeting measured by credible entities may be self-fulfilling. If
people believe that the central bank will reach its inflation target, they start to act accordingly.
For example, workers may require wage increases, at least in line with the expected inflation
target, which will ultimately lead inflation towards that level.
From other perspectivethe main characteristics of ITP which distinguishes it from the
other policies are explained in the following manner-
 There is a particular target which is set in this policy for the annual inflation.
 The inflation target is the de facto intermediate target.
 It has an important role in transparency, accountability and communication with the
public.
Thus these are the unique features of ITP which can clearly distinguish it from the other
policies. Therefore, it can be said that it is quite important that the Central Banks are able to
implement the finer details of this policy by understanding, analysing and interpreting these
features. The Economists have to make sure that they can implement the various types of
changes in the right manner effectively and efficiently(Chen and Creamer, 2019).
Prerequisites for inflation targeting policy
There are several prerequisites for the employment of inflation targeting and a successful
operation of the laid down policy regime identified in numerous scholarly articles.

The Effectiveness of the Inflation Targeting Policy9
Central bank independence-to spur economic growth, it is important that the central
bank is independent of political or any other influential governmental agencies from interference
and influence. This makes it easy and ethical when it comes to interest rate appraisal or
reduction.The Central Bank of a Country must be independent enough to ensure that the use of
ITP can help in managing the higher rate of inflation which is prevailing in the country. This will
be quite helpful in ensuring that the higher-level of economic growth can be targeted in the
future in the right manner.
Stability in country economy- low flow of capital improves the success probability of
inflation targeting. Very high rates of inflation lead to the substitution away from domestic
currency toward dollars or any other stable currencies(Fouejieu, 2017).Therefore, in this way it
can be said that the use of ITP can help in bringing the required amount of stability in the
economy helping it to aim towards economic growth.
Advanced and developed infra structure-with the presence of well-developed
institutions, the transmission of monetary policy mechanisms must be understood and should be
predictable. The connection between instruments and inflation results should be understood and
form the basis for the central bank staff to forecast inflation. These forecasts provide the reasons
for policy deliberation and, therefore, the technical capabilities of the central bank in
understanding mechanisms for monetary transmission, and the ability to forecast inflation.
Declare clear and determined target- coupled with abandoning of all other nominal
anchors and the clarity of price stability as the ultimate goal, the bank must see to fruition
monetary policy actions transparently, make known these actions to the general public, and
conclusively explain the deviations of inflation outcomes from targets efficiently with

The Effectiveness of the Inflation Targeting Policy10
appropriate and expected changes in policies to rectify these deviations. Each of these factors
have influenced the success of monetary policy after the implementation of inflation targeting.
(Roger, 2010, pg. 47).
There are some prerequisites which are required before the adoption of the ITP can be
done. The explanation of these prerequisites can be done in the following manner-
 Degree of independence of monetary policy- The monetary policy is quite important to
be applied within the economic context. Therefore, it is quite important from the point of
view of the economists that they are able to learn about the degree of independence
which they can allow in this policy which will help in ensuring that the independent
monetary decisions can be taken effectively and efficiently. During the turbulent times
which are faced by the economy, it is quite important that the Central Bank can take
tough decisions related with the monetary policy which will help a lot in ensuring that the
Inflation Targeting Policy can be implemented(Hatcher and Minford, 2016).
 Absence of commitment to a particular level of exchange rate- The absence of
commitment to a particular level of exchange rate is required because it is crucial in
ensuring that the higher-level of economic growth can be targeted. Thus, In this way it is
quite important from the point of view of Central Bank that it considers all the situations
in the market before taking a decision. If the exchange rate of the country is dependent
upon the situation which is prevailing in the market then it can ensure that the
implementation of the ITP can be done in the right manner(Hossain and Arwatchanakarn,
2017).
Who is in charge of ITP?
Inflation targeting is a monetary policy where the central bank sets a specific inflation
rate as its goal. The central bank does this to make you believe prices will continue rising
(Hammond, 2011). The Central Bank of the Republic of Turkey (CBRT) and the Turkish
Government is in charge of managing inflation with an inflation targeting policy.This tool is

The Effectiveness of the Inflation Targeting Policy11
used in order to make sure that the inflation rate can be controlled and thus the higher-level of
prices which are prevailing in the economy can be controlled in the right manner. When prices
rise at this speed, it drives consumer demand. Economic growth is spurred by shoppers buying
now to avoid higher prices later (Fouejieu,2017, pg. 51).
The implementation of Inflation Targeting Policy and the identification of the various types of
steps which can be undertaken for its implementation is a responsibility of the Central Bank of a
country. This is so because the Central Bank of a country is responsible for the identification of a
change in the different types of rates. Also it has to identify the changes in the monetary policy
so that the use of appropriate method and techniques can be made so that the economic growth
within the country can be boosted. Therefore, the Central Bank of a country is tasked with the
setting of Short-term, Medium-term and Long-term goals and objectives so that the target of
inflation for the public can be set and the appropriate steps and measures can be taken in the right
manner to control the rate of inflation(Kadria and Aissa, 2016).
Further, ensuring price stability through the use of ITP is an important objective in front
of a country's Central Bank. This is so because the prices of the different types of products can
face a lot of changes because of the dynamic situations which tend to prevail in the Business
Environment. Further, turbulent times in the economy can also lead towards price fluctuations.
Therefore, In this way it can be said that using ITP can be quite helpful in leading
towards bringing of stability in the prices in the country in the right manner.
If the prices are rising in the economy, then the rate of inflation will be quite high which will
definitely impact the level of demand in the economy. Thus, Here the Central Bank has to take
the necessary actions by bringing out the desired level of changes in the ITP so that the rate of
inflation can be controlled.
If the prices are decreasing in the economy, then the rate of inflation will be quite low which will
therefore impact the situation prevailing in the market. Therefore, the Central Bank here is
required to ensure that it can take the necessary actions so that the control on the rate of inflation
can be maintained effectively and efficiently(Kartaev, 2017).
The difficulties and obstacles in implementing the ITP in some countries
Numerous evidences today indicate that inflation targeting performs well in many
different types of economies. However, a number of difficulties and challenges arise for the

The Effectiveness of the Inflation Targeting Policy12
future in several countries. With the ballooning number of emerging markets and rapidly
developing economies adopting inflation targeting, a significant challenge is adapting a
framework that suits their circumstances (Abuselidze,2019). New emerging markets and
developing countries adapting inflation targeting encounter several obstacles that differ in
character or degree levels from those that more advanced economies face. These challenges
include;
Some of these problems and issues which can be faced while ensuring the
implementation of ITP in the countries are as follows-
1. Credibility of a systematic monetary policy framework- In a lot of countries there is
not particular monetary policy framework which is available which can be applied in
enhancing the credibility level in the right manner. This thus creates a barrier in the
implementation of ITP in the countries and therefore impacts them a lot(Kuzheliev and
et.al., 2020).
2. Adoption of IT as a part of the package of the economic reforms- In the countries, the
adoption of IT is leading towards a lot of problems and issues in relation to the economic
reforms. This is creating a lot of problems and issues related to IT systems and thus affect
these systems a lot. This therefore creates an impact on the implementation of ITP in the
various countries.
3. Weak financial sector institutions and markets- In the countries, the financial sector
institutions have become very weak and therefore an impact has also been created on the
financial markets. Therefore, In this way it can be said that this impacting the economic
situation which is prevailing in the different countries. This thus affects the
implementation of ITP in the different countries.
4. Role of the exchange rate- The exchange rate is an important parameter as by making its
use the different types of economic decisions are made. In some countries, there are
various types of fluctuations which are witnessed regularly in the exchange rates which
therefore creates problems and issues in the implementation of ITP. Therefore, it can be
said that this creates an impact on the economic decision-making.
5. Lack of proper implementation of economic policy- Lack of implementation of proper
implementation of economic policy can create a particular level of impact on the different
types of decisions which are required to be taken and can create an impact on the
economic decision-making. Therefore, it can be said that it can affect the implementation
of ITP in the countries and can therefore create a particular level of impact on the
implementation of important decisions which are related with ITP. Thus, it can be said
that it affects the economic situation in a particular country.