Interest Rates – Inflation Relationship Under Inflation Targeting Regime: The Case of Turkey

Abstract

This paper examines the relationship between nominal interest rate and the expected inflation rate for the Turkish economy between 2002 and 2009, a period when the inflation-targeting regime was implemented as monetary policy. We use the test of cointegrating rank with a trend-break; a method introduced by Inoue (1999), and we also apply exogeneity tests. Empirical findings indicate that monetary policy rates depend on inflationary expectations; long-term interest rates are affected by monetary policy; and the weak form of the Fisher effect is valid. This evidence implies that monetary policy has actually influenced the real long-term interest rates; the inflation targeting regime pursued by the Central Bank of Turkey is reliable; and hence realized inflation has remained close to its targeted level.

Keywords: Inflation targeting; Fisher effect; Term structure of interest rates; Cointegration with breaks; Exogeneity test

JEL Classification: E31, E43, E58