Turkish Experience with Inflation Targeting

Abstract: Inflation targeting (IT) has recently become a popular monetary policy tool to fight inflation in advanced as well as emerging market economies. IT is assumed to curtail inflationary expectations; aiding monetary authorities implement disinflationary policies. The evidence toward IT’s role in anchoring expectations in practice can be at best described as mixed, if not confusing. In this paper, we take the case of an emerging country, i.e. Turkey, which adopted inflation targeting as a policy framework after the failure of orthodox policy in 2001. We quantitatively examine the IT’s effectiveness in reducing inflation by comparing forecasted inflation levels based on pre-IT levels to the actual inflation levels following the adoption of IT. Furthermore, the possibility of a structural change following the adoption of IT is examined. We fail to find a structural break in inflation at the time of the adoption of IT in Turkey. We show that observed levels of inflation would not have been any different from the forecasted levels of inflation if IT had not been adopted. In other words, the ‘success’ in lowering chronic inflation in Turkey is turned into a ‘failure’ by not keeping inflation at the levels promised by the monetary authorities. However, we do not mean to put this finding as a negative judgment for IT as a policy framework. Under different conditions, it could be perfectly credible policy even for emerging markets.