Examination of the exchange rate and interest rate channels of the monetary transmission mechanism during the inflation targeting: Turkey and Mexico countries examples

Theoretical and Applied Economics Volume XXIV (2017), No. 4(613), Winter, pp. 137-160 Examination of the exchange rate and interest rate channels of the monetary transmission mechanism during the inflation targeting: Turkey and Mexico countries examples* Musa ATGÜR Necmettin Erbakan University, Konya, Turkey N. Oğuzhan ALTAY Ege University, İzmir, Turkey Abstract. In this paper, the efficiency of the exchange rate and interest rate channels were investigated of the monetary transmission mechanism (MTM) in Turkey and Mexico. Quarterly data are used for Turkey 2002I – 2013II period and for Mexico 2001I – 2013I period were analysed for both Countries using the VAR (Vector Autoregressive) and FAVAR (Factor Augmented Vector Autoregressive) econometric methods. Obtained the findings in this paper namely, VAR Model results impulse-response functions showed that partially work of the interest rate channel in Turkey and of the exchange rate channel in Mexico. FAVAR Model impulseresponse functions results have pointed out that did not work for both Countries of the exchange rate and interest rate channels. Keywords: exchange rate, interest rate channel, monetary transmission mechanism. JEL Classification: C50, E50, E52, E58. *This article was produced from Musa ATGÜR’s doctoral thesis titled “The Analysis of the Monetary Transmission Mechanism Using the FAVAR Method in Terms of Monetarist Approach”. 138 Musa Atgür, N. Oğuzhan Altay 1. Introduction Monetary policy implementations may affect the economies directly or indirectly through specific mechanisms. It is crucial to be anticipated by economic agents the possible impacts and consequences of the monetary policy of the central bank will implement knowledge of the effects on the income level and general price level of the monetary policy changes. It is defined and categorized in different ways of the Monetary Transmission Mechanism (MTM) concept and its channels. Monetary Transmission Mechanism (MTM) concept refers to the transmission on inflation of the monetary policy decisions (Taylor, 1995). According to Ireland (2005) MTM, is defined as the effects on the real variables of the policy-induced changes in nominal money stock or short-run nominal interest rate. MTM as a general framework, it is the mechanism explaining the effects the overall on the entire national economy indicators such as total production, employment and general price level to conduct monetary policy in a country where the authorities of monetary policy changes. MTM concept, before only when defined the effects on the aggregate demand and aggregate production today the effects on the general price level it will be investigated in addition to the effects on aggregate production. MTM has been working through some channels. MTM channels classified in different forms generally, it is classified as interest rates, exchange rates, asset prices and credit channels in the literature. Mishkin (1995) examined MTM channels under four headings as interest rates, exchange rates, asset prices and credit channels. Generally, MTM cannels are based on such as classification the MTM literature. Sznajderska (2011) added in addition to the expectations channel to the classification of the MTM channels Mishkin (1995) indicated that the bank loans (narrow credit channel), balance sheet and risktaking channels in studies conducted in recent years. On the other hand Boivin et al. (2010) were evaluated in two categories the MTM channels Neoclassical and non-Neoclassical that including financial market shortcoming. Neoclassical channels are considered as the MTM's core channels. Core channels are determined as short-term policy interest rate, long-term interest rates, asset prices and exchange rate. It is classified non-neoclassical channels as credit-based channels. Bofinger (2001) examined the MTM channels in three portions as quantity theory channel, interest rate channel and expectations channel (Phillips Curve). Besides similarities there are also differences among the classification describing MTM channels. Mishkin (1995), Boivin et al. (2010) and Sznajderska (2011) were classified more extensive MTM channels. It affects preferred monetary policy instruments and practices in a country transmission process of MTM closely affected by the financial and real variables. After the crisis, the significant transformations has occurred about monetary policy in some emerging economies where the financial crisis deeply affected. In this context, Central Bank of the Republic of Turkey (CBRT) has included the main purpose of price Examination of the exchange rate and interest rate channels of the monetary transmission mechanism 139 stability as well as financial stability for policy purposes on the basis of a new objective composition in monetary policy in the process after the global financial crisis. Mostly as econometric methods Vector Autoregressive (VAR) Model, Vector Error Correction (VECM) and Factor Augmented Vector Autoregressive (FAVAR) Model methods were used in studies on the efficiency of the MTM for developed and developing countries in MTM literature. In this paper, cause as examples of countries analysis Turkey's and Mexico's preference both countries it is to show similarities in terms of the phases in the economy and due to be implemented inflation targeting regime. There have been important developments both countries in monetary policies implementation after the financial crisis induced with the failure of the stability program applied in the close past. Before 1980, the monetary policies is applied based on Keynesian Approach in Turkey, after 1980, the monetary policies have been implemented based on Monetarist Approach. Monetarist monetary policies has been implemented but the effects of Keynesian monetary policies has been also seen in nineties years. The stabilization programs has been implemented based on the fixed exchange rate regime and these programs failed for both countries examined in this article in nineties years. The Central Bank of the Republic of Turkey (CBRT) has come to more active position in terms of the implementation of the monetary policies with the structural and institutional reforms after the November 2000 and February 2001 crises, CBRT provided the objective and instrument independence with the regulations made in the Central Bank Law No 1211. The inflation targeting regime has begun to be implemented implicit since 2002 and official since 2006. An economic stabilization program was implemented called “Pacto” and based on fixed exchange rate regime basis in Mexico in 1987. Mexico faced a monetary and finance crisis with the effect of international capital flows together with the financial liberalization process and implemented monetary and exchange rate policies in 1994. After the crisis, it is accepted that a contractionary monetary policy should be implemented and that the Central Bank should be transparent in monetary policy (...truncated)