Working Paper: CEPR ID: DP17248
Authors: Refet Gürkaynak; Bünyamin Kısakürek; Sang Seok Lee
Abstract: For the academic audience, this paper presents the outcome of a well-identified, large change in the monetary policy rule from the lens of a standard New Keynesian model and asks whether the model properly captures the effects. For policymakers, it presents a cautionary tale of the dismal effects of ignoring basic macroeconomics. In doing so, it also clarifies how neo-Fisherian disinflation may work or fail, in theory and in practice. The Turkish monetary policy experiment of the past decade, stemming from a belief of the government that higher interest rates cause higher inflation, provides an unfortunately clean exogenous variance in the policy rule. The mandate to keep rates low, and the frequent policymaker turnover orchestrated by the government to enforce this, led to the Taylor principle not being satisfied and eventually a negative coefficient on inflation in the policy rule. In such an environment, was the exchange rate still a random walk? Was inflation anchored? Does the "standard model" suffice to explain the broad contours of macroeconomic outcomes in an emerging economy with large identifying variance in the policy rule? There are no surprises for students of open-economy macroeconomics; the answers are no, no, and yes.
Keywords: Central Bank Independence; Taylor Principle; Weak Monetary Policy; Effective Upper Bound; Currency Crisis; Inflation Spirals; Emerging Markets
JEL Codes: E02; E31; E52; E58; F31; F41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Change in the monetary policy rule (E52) | Turkish economy (O53) |
| Violation of the Taylor principle (E19) | Indeterminacy in inflation (E31) |
| Failure to satisfy the Taylor principle (E19) | Inflation outcomes (E31) |
| Lower interest rates do not signal credible commitment to lower inflation targets (E43) | Spiraling inflation (E31) |
| Domestic factors (institutional quality) (O17) | Co-movement between inflation and exchange rate depreciation (E31) |
| Inflation trends (E31) | Exchange rate trends (F31) |
| Political pressures on the central bank (E58) | Ineffective monetary policy (E49) |
| Ineffective monetary policy (E49) | Exacerbated inflationary pressures (E31) |