Effectiveness of monetary policy: evidence from Turkey

Abstract

An effective monetary policy framework is often viewed as a pre-condition for well-functioning financial markets. Yet measuring monetary policy effectiveness is not straightforward; it requires empirical work to understand the impact of financial infrastructure, competitiveness of financial markets, and current economic conditions. In particular, monetary policy effectiveness depends on the extent to which the chosen interest rate affects all other financial prices—including the entire term structure of interest rates, credit rates, exchange rates, and asset prices. This paper examines the effectiveness of monetary policy in Turkey by focusing on interest rate pass-through outcomes by way of an interacted vector autoregressive (IVAR) approach. The results suggest that policy-led rate changes are fully transmitted to deposit and credit rates within eight months. Competition in the banking sector (as well as that sector’s liquidity and profitability), dollarization, exchange rate flexibility, inflation, and term structure all have a positive effect on interest rate pass-through; whereas regulatory quality, GDP growth, monetary growth, industrial growth, and capital inflows have a negative effect. Using various tests, we find that the effect of financial development and macroeconomic variables on interest rate pass-through is neither robust nor time-invariant.