Using of developments of the last decade in Bayesian estimation, I estimate a small open economy Dynamic Stochastic General Equ ilibr ium (DSGE) model fo r Turkey. The thesis explicitly accounts for a monetar y regime change fro m an exchange rate targeting to an exp licit inflation targeting with a flexible exchange rate. In both regimes, I investigate the behavior of the monetary authority and the main driving forces of business cycles of key macro economy variables of the Turkish economy. My results can be summarized as follows. Monetary policy focused on the stabilizing of the nominal exchange rate in the exchange rate targeting regime. But, it is mainly concerned with the price stability in the inflation targeting reg ime. Monetary policy shocks were the main sources of the fluctuations under both regimes. However, the foreign output shock in the first regime and the real exchange rate shock in the second regime appeared as the additional sources of the fluctuations in the business cycles. The Central Bank of Tur key managed to neutralize inflatio nary sho cks and achieved stability in output and consumption after the regime change.
Keywords: Turkey, Bayesian estimation, DSGE models, regime change
Table of Contents
1. Introduction
2. Derivation of the baseline model
2.1. Households
2.2. Inflation, the real exchange rate and terms of trade
2.3. International Risk Sharing Condition
2.4. Firms
2.5 Price setting behavior and incomplete path through
2.6. Equilibrium
3. The estimation methodology
3.1 Specification of the data and prior distribution
4. Results
4.1 Parameter estimation and posterior distribution
4.2. Variance decomposition and Impulse response
Conclusion
Reference
Appendix A
Appendix B
Research Objectives & Core Themes
The primary objective of this thesis is to estimate a small open economy Dynamic Stochastic General Equilibrium (DSGE) model for Turkey, explicitly accounting for the monetary regime shift that occurred in 2001. The research investigates how the monetary authority's behavior and the main driving forces of business cycles in key macroeconomic variables evolved when transitioning from an exchange rate targeting regime to an explicit inflation targeting regime with a flexible exchange rate.
- Bayesian estimation of DSGE models for emerging economies.
- Quantitative assessment of two distinct monetary policy regimes in Turkey.
- Analysis of structural shocks and their contributions to business cycle fluctuations.
- Evaluation of the Central Bank of Turkey's performance in stabilizing inflation and output.
- Comparison of economic volatility and price rigidity before and after the 2001 regime change.
Excerpt from the Book
1. Introduction
Until 21 February 2001, the Turkish economy was "ruled" by a fixed exchange rate regime towards the USD. In this period Turkey had a very inflated economy. The main reasons of inflation and consequently economic crises were income-expenditure disbalances in the public sector. Lack of structural and financial reforms made the economy vulnerable to foreign shocks and resulted in several serious inflationary crises in 1988-1989, 1991, 1994 and 1998-1999. In 2000, IMF supported stabilization and disinflation program aimed at tying down inflation which reached a level of 80% and at establishing financial stability. An exchange rate based disinflation and monetary control mechanism set certain tasks for the Central Bank (CB), such as not violating net domestic asset position and avoiding sterilization. But, insufficient funding from ongoing privatization programs and inefficient structural reforms forced the government to continue borrowing at higher interest rates. This led to a loss of monetary policy credibility in both domestic and foreign markets which resulted in further loss of confidence in the ruling authority and an increase of the devaluation expectations. Thus, defending predetermined exchange rate parity was beyond the CB's scope and in February 2001 the Central Bank abandoned fixed parity and let the exchange rate float.
After the currency collapse, the monetary authority switched to a different monetary policy regime, which is a very typical for an emerging market economy which abandons fixed parity. As stated by Taylor (2000), in this case the best policy to stick to for an emerging economy is a flexible exchange rate, an inflation target and a monetary policy rule. As a result, Turkey opted to an inflation targeting regime with a floating exchange rate. The CB continued using short-term interest rates as the main policy tool to reach its policy target in the second regime.
Summary of Chapters
1. Introduction: Outlines the historical context of the Turkish economy, detailing the transition from a fixed exchange rate regime to an inflation targeting regime in 2001 and establishing the thesis's core research goals.
2. Derivation of the baseline model: Provides the theoretical foundation by constructing a small-scale open economy DSGE model, incorporating household utility, firm production, and monetary policy rules.
3. The estimation methodology: Describes the Bayesian estimation techniques and the utilization of the Kalman filter and Markov-Chain Monte Carlo (MCMC) methods to analyze the model using Turkish data.
4. Results: Presents the parameter estimates and variance decomposition analysis to compare the Turkish economy's performance across the two defined monetary policy regimes.
Conclusion: Synthesizes the findings, highlighting how the regime change influenced the sources of economic volatility and confirming the effectiveness of the inflation targeting policy in stabilizing the economy.
Keywords
Turkey, Bayesian estimation, DSGE models, monetary regime change, inflation targeting, exchange rate targeting, business cycles, monetary policy rule, structural shocks, variance decomposition, impulse response, macroeconomic stability, nominal interest rate, price stickiness, small open economy
Frequently Asked Questions
What is the core focus of this research?
The work primarily focuses on modeling and analyzing the Turkish economy's behavior during its transition from a fixed exchange rate targeting regime to an explicit inflation targeting regime using a Dynamic Stochastic General Equilibrium (DSGE) framework.
What are the main thematic areas covered?
The core themes include Bayesian macro-econometric modeling, the evaluation of monetary policy effectiveness, the identification of business cycle drivers, and the impact of structural economic reforms in an emerging market context.
What is the primary goal of the thesis?
The primary goal is to estimate monetary policy rules for both regimes to verify if the Turkish data reflects the officially announced regime change and to identify which specific economic shocks were responsible for driving business cycle fluctuations in Turkey.
What scientific methods are utilized?
The study employs Bayesian estimation techniques, including the use of likelihood functions, Kalman filters for state-space representation, and Markov-Chain Monte Carlo (MCMC) algorithms for posterior distribution analysis.
What topics are discussed in the main body?
The main body details the mathematical derivation of the DSGE model (households, firms, price setting, equilibrium), the specific estimation methodology, and the analysis of parameter estimates, variance decompositions, and impulse response functions.
Which keywords best characterize this work?
Key terms include Turkey, Bayesian estimation, DSGE models, monetary regime change, inflation targeting, and business cycle analysis.
How did the central bank's policy change affect economic volatility?
The findings indicate that while the inflation targeting regime improved price stability, it also left the Turkish economy more vulnerable to fluctuations driven by real exchange rate shocks compared to the previous regime.
What role does the real exchange rate play in the inflation targeting regime?
The research concludes that in the second regime, the real exchange rate emerged as a significant source of economic volatility, effectively transmitting foreign shocks into the Turkish economy.
- Quote paper
- Samir Huseynov (Author), 2010, An Estimated DSGE Model For Turkey With A Monetary Regime Change, Munich, GRIN Verlag, https://www.hausarbeiten.de/document/154551
