Central Bank decisions and post-meeting communications have continued to dominate the economic agenda. Although I give the Central Bank the benefit of the doubt and will wait and see the results of recent decisions, it is clear that the policy rate cut accompanying the increased reserve requirement has generated reaction from some analysts who think price stability should be the overriding concern of a central bank. Since the expectations channel is vital for transmitting monetary policy to the real economy, inability to shape expectations as desired could be an obstacle to the effectiveness of the latest efforts. I think the Central Bank of Turkey got this message from market players. In return, the Central Bank is trying to convince decision-makers that the rate cut has nothing to do with the inflation outlook, which is very promising in the short term; it is indeed an element in a policy mix that has two main goals.
According to the Central Bank, the first goal of the current policy mix is reducing the pace of credit growth and the second goal is fostering longer maturity periods for capital inflows. It seems that a lower policy rate is very much related to the second goal of discouraging short-term capital inflows mainly in the form of swap transactions with non-residents. As a supplement to this, the Central Bank also widens the corridor between overnight borrowing and lending rates so as to allow fluctuations in the short-term interest rates when needed. As Central Bank Gov. Durmuş Yılmaz confirmed in a TV interview, this strategy was quite successful in driving away hot money and causing the recent depreciation of the Turkish Lira. I also saw from banks’ rapidly shrinking off-balance sheet transactions that it is actually happening. This is important for improving the quality of the capital account and avoiding exchange rate movements detached from economic fundamentals. However, it could also imply that another rate cut would not be needed if the second goal were accomplished. On the first goal, the Central Bank said higher effective required reserve ratios are anticipated to curb credit growth through the cost and liquidity channels starting from January. This means the composition and the direction of the policy instruments in the forthcoming period will be dependent on credit growth and capital flows data.
The Central Bank sent clear signals about the inflation outlook in the summary notes from its monetary policy meeting as an important part of its communication strategy. First, headline inflation is expected to be close to the end-2010 target of 6.5 percent. Second, inflation will decline in the forthcoming period. Third, the output gap still exists and will help to limit the pass-through from commodity prices to the prices of core goods and services. However, the bank remained cautious by highlighting the sharp increases in agricultural commodity prices (cotton and wheat) and the rapid pace of domestic demand. The bank said the impact of commodity prices on general price-setting behavior should be closely monitored.
Last but certainly not the least, the Central Bank clearly said the net impact of the macro-prudential policy package implemented – and to be implemented – both by itself and at other institutions should be on the tightening side. While this statement makes measuring the policy stance even more difficult, it also increases the importance of the Central Bank’s credibility. So it all depends on do you trust the bank or not?...
The Central Bank has been harshly criticized for not mentioning the importance of fiscal discipline in the fight against the current account deficit while bringing new burdens to the banking system. In the meeting notes, the Central Bank said increasing government savings is essential for containing the risks regarding the current account deficit and applauded the control of budget expenditures during 2010 as envisaged in the country’s medium-term program, while underlining the vitality of maintaining fiscal discipline in the period ahead.
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