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Unformatted text preview: INFLATION, INFLATION UNCERTAINTY, AND MONETARY
POLICY IN TURKEY: 1960 1998
TEVFIK F. NAS AND MARK J. PERRY* The authors constructed a time series of monthly inﬂation uncertainty in Turkey
from 1960 to 1998 using GARCH models and in¨ estigated the link between inﬂation
and inﬂation uncertainty using Granger tests. The authors found strong statistical
support that inﬂation signiﬁcantly raised inﬂation uncertainty in Turkey o¨ er the full
sample period and three subsamples. The e¨ idence on the effect of inﬂation
uncertainty on a¨ erage inﬂation is mixed and depends on the time period examined.
An analysis of the political conditions and the record of macroeconomic policymaking in Turkey between 1960 and 1998 re¨ eal institutional and political factors that
can help explain the empirical results. Ž JEL E310, 1342, 1340. I. INTRODUCTION found in the United States, United Kingdom,
and Germany, where increased inﬂation uncertainty lowers average inﬂation.
In the present study, following the
methodology used in Grier and Perry Ž1998.,
we constructed a time series of monthly inﬂation uncertainty in Turkey from 1960 to
1998 using generalized autoregressive conditional heteroskedastic ŽGARCH. models and
investigate the link between inﬂation and
inﬂation uncertainty using Granger tests.
This article found strong statistical support
that inﬂation signiﬁcantly raises inﬂation uncertainty in Turkey over the full sample period and three subsamples, conﬁrming the
prediction of Ball Ž1992.. Test results for
whether inﬂation uncertainty lowers or raises
subsequent inﬂation are mixed and depend
on the time period tested. Overall, stabilizing
policy behavior seems to prevail, especially
in the long run, since higher inﬂation uncertainty is associated with lower average inﬂation at some lag lengths in each sample
period investigated. This article found evidence of opportunistic policy behavior in the
short run during the late 1980s and 1990s,
when inﬂation uncertainty raised average inﬂation. An examination of the political conditions and the record of macroeconomic An extensive body of both empirical and
theoretical literature focuses on the relationship between the rate of inﬂation and inﬂation uncertainty. Recent studies by Brunner
and Hess Ž1993., Evans and Wachtel Ž1993.,
and Ball and Cecchetti Ž1990. found statistical support for a positive association between the rate of inﬂation and inﬂation uncertainty in the United States. Theoretical
studies by Cukierman and Meltzer Ž1986.,
Cukierman Ž1992., and Ball Ž1992. address
the issue of the direction of causality between inﬂation and inﬂation uncertainty. Ball
claims that higher inﬂation creates greater
inﬂation uncertainty, while according to
Cukierman and Meltzer inﬂation uncertainty
leads to higher average inﬂation due to opportunistic central bank behavior Žpolitically
motivated expansionary policy.. Recent empirical work focuses speciﬁcally on the direction of causality between inﬂation and inﬂation uncertainty. Holland Ž1995. found that
inﬂation raises inﬂation uncertainty in the
United States and that higher inﬂation uncertainty leads to lower average inﬂation due
to stabilization motives of policymakers.
Grier and Perry Ž1998. showed that inﬂation
signiﬁcantly raises inﬂation uncertainty in all
G7 countries but that increased inﬂation
uncertainty raises inﬂation only in Japan and
France. Evidence of stabilizing behavior is ABBREVIATIONS *Nas: Professor of Economics, University of MichiganFlint, Fax 18107623281, Email tnas@umich.edu
Perry : Assistant Professor of Economics, University of
MichiganFlint, Fax 18107623281, Email mjperry@
umich.edu CB: Central Bank
GARCH: Generalized Autoregressive
Conditional Heteroskedastic 170
Contemporary Economic Policy
ŽISSN 10743529.
Vol. 18, No. 2, April 2000, 170 180 Western Economic Association International NAS & PERRY: INFLATION IN TURKEY policy making in Turkey between 1960 and
1998 reveal institutional and political factors
that explain our empirical results.
Section II reviews the theoretical and empirical literature on the relationship between
inﬂation and inﬂation uncertainty. Section
III discusses measures of inﬂation uncertainty and shows how GARCH models can
be used to construct a time series measure of
inﬂation uncertainty. In sections IV and
V the authors present empirical results
and discuss how the policy environment in
Turkey over this period can help explain
these ﬁndings. Conclusions are presented in
section VI.
II. INFLATION AND INFLATION
UNCERTAINTY Okun Ž1971. ﬁrst argued that inﬂation is
positively associated with inﬂation uncertainty because monetary policy becomes
more unpredictable during periods of high
inﬂation. Friedman Ž1977. emphasized the
positive link between inﬂation and inﬂation
uncertainty, because of the stopandgo
monetary policy that accompanies inﬂationary periods. According to Okun and Friedman, high inﬂation produces political pressure to reduce it, but policy makers may be
reluctant to disinﬂate because they fear the
recessionary effects of contractionary monetary policy. Because future monetary policy
is more difﬁcult for the public to predict in
high inﬂationary periods, higher average inﬂation results in greater uncertainty about
future inﬂation.
Ball Ž1992. formalizes the insights of Okun
and Friedman. In Ball’s model, there are two
types of policy makers who rotate in ofﬁce:
one is willing to tolerate a recession to reduce inﬂation, and the other is not. When
inﬂation is low, both types of policy makers
will attempt to keep it low, but when inﬂation is high, only the antiinﬂation policy
maker will bear the economic costs of disinﬂation. A repeated game takes place between the public and the monetary authority
as policy makers rotate in ofﬁce. During
periods of high inﬂation, there is greater
uncertainty about future monetary policy
since the public does not know how long it
will take for an antiinﬂation policy maker to
come into power and lower inﬂation. Ball’s
model provides theoretical support that 171 higher inﬂation creates greater uncertainty
about future inﬂation.
In contrast, Cukierman and Meltzer
Ž1986., and Cukierman Ž1992. argue that the
causality runs in the other direction, that
greater uncertainty about inﬂation causes
higher average inﬂation. The central bank
faces a tradeoff because it dislikes inﬂation
but values the higher employment from
monetary surprises. If monetary policy is discretionary and there is a lack of a commitment mechanism, Cukierman and Meltzer’s
model predicts an inﬂationary bias during
periods of increased uncertainty. Since it is
harder to assess policymaking when uncertainty is high, there is an increased incentive
for the central bank to act opportunistically
and create inﬂation surprises during periods
of increased inﬂation uncertainty.
However, Holland Ž1995., Grier and Perry
Ž1998., and Balvers and Cosimano Ž1994.
argue that shortterm opportunistic behavior
in periods of inﬂation uncertainty is not the
only possible policy response by the central
bank. Policy makers could either Ža. have
longterm stabilizing motives, Žb. be governed by some commitment mechanism that
requires price level stability, or Žc. be inﬂuenced by International Monetary Fund
aided shifts toward stabilization and attempt
to reduce the welfare costs of inﬂation by
disinﬂating when inﬂation uncertainty is high.
In these cases, there would be a negative
relationship between inﬂation uncertainty
and average inﬂation, due to the longterm stabilization motives of the monetary
authorities.
III. MEASURING INFLATION UNCERTAINTY Early researchers measured inﬂation uncertainty as the standard deviation of inﬂation, and conducted international studies
showing that countries with higher average
inﬂation have more variable inﬂation. Two
time series measures of inﬂation uncertainty
were later developed: Ž1. the crosssectional
dispersion of inﬂation forecasts from surveys
of professional economists and Ž2. the moving standard deviation of the inﬂation rate.
These measures of inﬂation uncertainty
do not necessarily capture the type of uncertainty modeled by Ball Ž1992. or Cukierman
and Meltzer Ž1986., where uncertainty is the
variance of the unpredictable component of 172 CONTEMPORARY ECONOMIC POLICY inﬂation. Surveybased measures of inﬂation
summarize the dispersion among forecasters
at a point in time, but do not measure each
forecaster’s certainty about their inﬂation
forecast. It is possible that, in a given period,
each forecaster could be extremely uncertain
about inﬂation and yet submit similar point
estimates of future inﬂation. The surveybased measure of inﬂation uncertainty would
then signiﬁcantly underestimate the actual
level of uncertainty about future inﬂation.
Likewise, the predictable ﬂuctuations in inﬂation will show up in a standard deviation
measure of inﬂation uncertainty even though
there may be no actual uncertainty. In that
case, the moving standard deviation of inﬂation could signiﬁcantly overstate the actual
level of uncertainty.
In contrast to these ad hoc measures of
inﬂation uncertainty, recent econometric advances in ARCH and GARCH time series
estimation provide a more sophisticated
method of estimating timevarying uncertainty Žsee Engle w1983x for further details on
ARCH models and Bollerslev w1986x for
GARCH models.. GARCH models can
parametrically estimate the variance of
stochastic innovations in a variable, rather
than simply constructing a variability measure from past outcomes Žmoving standard
deviation. or the dispersion of individual inﬂation forecasts. Note that, in a parametric
model, the distribution and characteristics of
a population are assumed to be known and
statistical inferences are made based on these
assumptions. A GARCH model estimates a
timevarying conditional error variance that
corresponds well to the uncertainty in the
theoretic models of Ball Ž1992. and Cukierman and Meltzer Ž1986..1
Furthermore, since GARCH models provide a parametric measure of inﬂation uncertainty, an explicit test can be conducted
to determine if the conditional variance is
statistically signiﬁcant. Therefore, we can
conduct a statistical test of the null hypothesis that inﬂation uncertainty is constant over
the sample period. While the survey or variabilitybased measures of inﬂation uncertainty previously used do ﬂuctuate over time,
1. In another area of the inﬂationinﬂation uncertainty literature, an attempt is made to separate longrun
from shortrun inﬂation uncertainty. For example, see
Ball and Cecchetti Ž1990. and Evans and Watchel Ž1993.. there is no way to test whether those ﬂuctuations are statistically signiﬁcant. GARCH
models, therefore, represent a signiﬁcant advancement in the estimation of uncertainty
and are now used extensively in the economic and ﬁnance literature.
In the present study, we estimate
GARCHŽ1,1. models for Turkish inﬂation
and then use the timevarying residual variance Ž 2t . as a time series of inﬂation uncertainty. A general ARMAGARCHŽ1,1.
model for inﬂation is
n Ž1.
Ž2. ts
2
t 0q s 0 Ý i ty i q q 2
1 ty 1 q is 1 ty i 2 q t, 2
ty 1 . Equation Ž1. is a standard, timeseries model
of inﬂation, where the conditional mean of
Turkish inﬂation is assumed to follow an
autoregressive, moving average ŽARMA.
process. Inﬂation at time t is simply a function of past values of inﬂation ŽAR terms.
and past values of the error term ŽMA terms..
Following the standard approach used in the
timeseries literature to model macroeconomic variables over time, the optimal lag
length Ž n. in equation Ž1. is selected based
on Ža. an inspection of the inﬂation correlogram of the autocorrelations and partial correlations, Žb. Q tests for serial correlation in
the subsequently estimated inﬂation equations, and Žc. an inspection of the correlograms of the inﬂation residuals from estimated ARMA equations for inﬂation. An
ARMA speciﬁcation for inﬂation should adequately capture all serial correlation to ensure that the residuals are white noise.
Equation Ž2. is a GARCHŽ1,1. representation of the conditional variance of inﬂation, and 2t is our GARCH measure of
inﬂation uncertainty. We consider other representations of the GARCH process, but ﬁnd
that GARCH Ž 1,1 . is the best. The
GARCHŽ1,1. model of 2t in equation Ž2.
implies that the conditional error variance of
inﬂation at time t depends on the squared
error from the inﬂation equation in time
period t y 1 and the conditional variance
from time period t y 1. In periods when
inﬂation uncertainty is low Žhigh., the error
term ty 1 will be small Žlarge., the squared
error term 2y 1 in next period’s conditional
t NAS & PERRY: INFLATION IN TURKEY variance will be small Žlarge., and the conditional error variance in time period t will be
small Žlarge.. Since a large error in one period Ža high level of uncertainty . could affect
more than one future period, the lagged
conditional variance of inﬂation Ž 2ty 1 . enters as a regressor to allow for inﬂation
uncertainty to persist through time.
IV. EMPIRICAL RESULTS This section examines the relationship between inﬂation and inﬂation uncertainty in
Turkey using the monthly consumer price
index from January 1960 through March
1998. We begin with the time series model
described in equations Ž1. and Ž2. to jointly
estimate the conditional mean and conditional variance of Turkish inﬂation and to
generate a parametric, times series measure
of inﬂation uncertainty. Next we conduct
Grangercausality tests to provide statistical
evidence of the relationship, including the
direction of causality, between inﬂation and
inﬂation uncertainty. Three subsample peri 173 ods are also investigated. The results of these
tests allow us to determine whether opportunistic policy behavior or stabilizing behavior prevails in Turkey.
A. A GARCH Time Series Model for Turkish
Inﬂation
It is necessary ﬁrst to establish that Turkish inﬂation is stationary, that the residuals
of the timeseries model of inﬂation are uncorrelated, and that the conditional variance
of inﬂation is signiﬁcantly timevarying. We
use PhillipsPerron and augmented DickeyFuller ŽADF. tests of the null hypothesis that
Turkish inﬂation has a unit root. Both tests
reject the null hypothesis of a unit root in
Turkish inﬂation at the 0.01 level, indicating
that the inﬂation rate in Turkey is stationary.
Table 1A shows the results of a times
series model for the inﬂation rate that includes eight lags of inﬂation and a 12th
order moving average term. Using standard
BoxJenkins techniques, we ﬁnd that this
speciﬁcation is the bestﬁtting time series TABLE 1
Time Series Models of the Turkish Inﬂation Rate
A. Least Squares Results
Ł t s 7.425 q 0.375 Ł ty 1 q 0.063 Ł ty 2 q 0.192 Ł ty 3 y 0.068 Ł ty 4 y 0.032 Ł ty 5 y
Ž 3.21.
Ž 8.00.
Ž 1.27.
Ž 3.84 .
Ž 1.35.
Ž 0.62.
0.003 Ł ty 6 q 0.037 Ł ty 7 q 0.200 Ł ty 8 q 0.146 ty 12 q t
Ž 0.07.
Ž 0.075.
Ž 4.29.
Ž 3.02.
Loglikelihood s y2122
R 2 s .390
QŽ4. s 1.25 QŽ8. s 4.7 QŽ12. s 11.4
Q 2 Ž4. s 24.0 Q 2 Ž8. s 24.1 Q 2 Ž12. s 24.3
Chow test for structural stability of estimated coefﬁcients ŽBreakpoint: 1980.01.: F s 13.2, p s .192
B. GARCH(1, 1) Results
Ł t s 6.549 q 0.556 Ł ty 1 y 0.059 Ł ty 2 q 0.166 Ł ty 3 y 0.024Ł ty 4 y 0.019 Ł ty 5 y
Ž 3.13.
Ž 8.12.
Ž 0.93.
Ž 2.38.
Ž 0.39.
Ž 0.34.
0.018 Ł ty 6 q 0.013 Ł ty 7 q 0.165 Ł ty 8 q 0.114 ty 12 q t
Ž 0.30.
Ž 0.27.
Ž 3.30.
Ž 3.90.
s 211.5 q 0.355 2y 1 q 0.378 2ty 1
t
Ž 6.21.
Ž 7.09.
Ž 5.52.
Loglikelihood s y2070
R 2 s .365
QŽ4. s 6.2 QŽ8. s 8.2 QŽ12. s 16.0
Q 2 Ž4. s 43.8 Q 2 Ž8. s 5.17 Q 2 Ž12. s 6.17
2
t Numbers below the coefﬁcients are tstatistics. Sample is monthly from 1960.01 through 1998.03. QŽ x . is the
LjungBox statistic for x th order serial correlation in the residuals, and Q 2 Ž x . is the statistic x th order serial
correlation in the squared residuals. Critical values at the 0.05 level of signiﬁcance are 9.4, 15.51, and 21.0 for 4, 8, and
12 lags, respectively. Data were obtained from Global Financial Data ŽLos Angeles, Calif... 174 CONTEMPORARY ECONOMIC POLICY model for Turkish inﬂation over the full
sample period and results in residuals that
are white noise.2 LjungBox Qtests on the
residuals show no sign of autocorrelation at
4, 8, or 12 lags, indicating that this model
accounts for any serial correlation in the
error terms. However, Q 2 test statistics on
the squared residuals are signiﬁcant at the
0.05 level for 4, 8, and 12 lags, indicating that
the inﬂation error variance is signiﬁcantly
time varying. The ARŽ8. 12th order moving
average regression model captures any pattern in the conditional mean of inﬂation, but
does not account for the strong pattern in
the conditional error variance. In addition, a
Chow test of the null hypothesis that the
estimated parameters are stable over time is
insigniﬁcant, indicating that the model is
structurally stable. 3
Table 1B adds a GARCHŽ1,1. model of
the conditional variance of inﬂation to the
time series model of the conditional mean of
inﬂation. Qstatistics for the residuals reveal
no pattern in either the residuals or the
squared residuals. The ARŽ8., MAŽ12.GARCHŽ1,1. model is the bestﬁtting times
series model of both the conditional mean
and variance of Turkish inﬂation.4 The
residuals and squared residuals are white
noise, and no other model results in a higher
loglikelihood function. 2t is used as our
time series measure of inﬂation uncertainty
in subsequent Granger tests of the relationship between the rate of inﬂation and inﬂation uncertainty. B. GrangerCausality Tests
Given our time series measure of inﬂation
uncertainty in Turkey, we can now examine
the relationship between inﬂation and inﬂation uncertainty using Grangercausality
tests.5 The results of these tests are reported
in Table 2. Over the full sample period
Ž1960.1 1998.3., the null hypothesis that inﬂation does not Grangercause inﬂation uncertainty is rejected at the 0.01 level using 4,
8, 12, 16, or 24 lags. Furthermore, since the
sum of the coefﬁcients is positive in all cases,
these results indicate that an increase in the
Turkish inﬂation rate ‘‘Grangercauses’’
greater inﬂation uncertainty.6 The null hypothesis that uncertainty does not Grangercause inﬂation is also rejected at the 0.01
level for all lags. The sum of the coefﬁcients
on lagged uncertainty in the inﬂation equation is negative, indicating that increased
inﬂation uncertainty leads to lower future
inﬂation over the full sample period.
The Granger tests reveal that there is
bidirectional causality between inﬂation and
inﬂation uncertainty. The ﬁrst set of Granger
tests in Table 2A show that increased inﬂa 5. The Granger approach allows us to examine the
questions of interest in this article whether inﬂation
ŽINF. ‘‘Grangercauses’’ inﬂation uncertainty ŽUNC. and
whether UNC ‘‘Grangercauses’’ INF. The equations to
be estimated in the pairwise Grangercausality test are
k Ž 3 . UNC t s k Ý i is 1 UNC ty i q k 2. Our main results in the paper do not depend on
the exact times series model of inﬂation wARŽ8. MAŽ12.x.
For example, the following models yield similar results:
Ža. ARŽ12.; Žb. AR Ž8., AR Ž12., and an ARŽ8. MAŽ12.
model where the insigniﬁcant regressors are dropped.
3. Evans Ž1991. uses an ARCH speciﬁcation for
inﬂation uncertainty and also allows for timevarying
parameters to capture structural changes in U.S. inﬂation over time. Since we ﬁnd that our basic model of
Turkish inﬂation is structurally stable over the full sample period according to the Chow test, we do not attempt to estimate a timevarying parameter model.
4. The estimated coefﬁcients in the variance equation are signiﬁcant at the 0.01 level, as can be seen by
their individual tstatistics as well as by noting that the
log of the likelihood function increases from y2122 to
y2070 from panel A to panel B. The two estimated
slope coefﬁcients in the GARCH equation sum to less
than 1.0 Ž.733., which is a requirement for stability of
the GARCH process. Speciﬁcations other than
GARCHŽ1, 1. were estimated, but no other model had a
higher loglikelihood function. Ž 4 . INFt s Ý is 1 Ý is 1 i INFty i q t, k
i q INFty i q Ý is 1 i UNC ty i q ut , where k is the number of lags speciﬁed, and we test the
null hypothesis that INF ŽUNC. does not cause UNC
ŽINF. in equation Ž3. wEquation Ž4.x. INF will Grangercause UNC in equation Ž3., if after controlling for k
lags of uncertainty, the k lags of inﬂation have explanatory power as a group in predicting uncertainty using an
Ftest of joint signiﬁcance of the inﬂation lags. Likewise,
inﬂation uncertainty will Grangercause inﬂation in
equation Ž4., if the lags of uncertainty have signiﬁcant
explanatory power as a group.
6. Standard Grangercausality models are a test of
temporal ordering between two variables and do not
reveal the sign of the relationship. That is, variable X
could be found to Grangercause variable Y , but whether
X raises or lowers Y would be obvious from a Granger
test. Therefore, we also calculate and report the sum of
the coefﬁcients from each Granger equation to determine whether the Granger causality, when found, is
positive or negative. NAS & PERRY: INFLATION IN TURKEY tion ﬁrst raises inﬂation uncertainty as predicted by Friedman Ž1977. and Ball Ž1992..
However, inﬂation and the associated uncertainty create real economic costs, which lead
to monetary tightening to lower inﬂation.
This stabilization behavior is reﬂected in the
second set of Granger tests in Table 2A,
where increased inﬂation uncertainty lowers
the subsequent rate of inﬂation. C. Subsample Periods
We next investigate the relationship between inﬂation and inﬂation uncertainty in
three subsample periods that were selected
based on major changes that took place in
the economic and policy environment in
Turkey. We examined the 1980 1998,
1986 1998, and the 1990 1998 periods because Ža. in 1980 Turkey began its economic
stabilization and trade liberalization, Žb. in
1986 a series of new legislation was intro 175 duced to allow the Turkish Central Bank to
conduct open market operations and monitor the newly created interbank market, and
Žc. in 1990 major steps were taken to increase central bank autonomy. In each sample period, the best time series model for
inﬂation is determined for each period using
standard BoxJenkins techniques. A
GARCHŽ1,1. model is used to generate a
time series of inﬂation uncertainty with information from that time period only.7 These
results are reported in Table 2B D.
For all three subsample periods, the effect
of inﬂation on inﬂation uncertainty is consistently positive and signiﬁcant. At all lag
lengths and in all sample periods, we found
that higher inﬂation is associated with higher
7. The results of the inﬂation time series model for
the subsample periods are not reported to save space.
Several additional subsample periods were considered,
but because of unstable GARCH equations they were
not suitable. TABLE 2
Granger Causality Tests for Inﬂation and Inﬂation Uncertainty in Turkey
Number of
Lags
A. 1960.1
4
8
12
16
24
B. 1980.1
4
8
12
16
24
C. 1986.1
4
8
12
16
24
D. 1990.1
4
8
12
16
24 1998.3 1998.3 1998.3 1998.3 H0 : Inﬂation does not
Grangercause inﬂation
uncertainty H0 : Inﬂation uncertainty
does not Grangercause
inﬂation 30.63***Žq.
16.57***Žq.
11.83***Žq.
9.79***Žq.
8.78***Žq. 5.66***Žy.
2.93***Žy.
2.95***Žy.
2.16***Žy.
1.96***Žy. 46.07***Žq.
23.80***Žq.
18.22***Žq.
14.49***Žq.
9.72***Žq. 2.14*Žy.
1.08
1.87**Žy.
1.34
1.07 46.31***Žq.
22.89***Žq.
15.63***Žq.
12.08***Žq.
8.73***Žq. 4.38***Žq.
3.83***Žq.
2.83***Žy.
2.66***Žy.
2.17***Žy. 43.72***Žq.
22.93***Žq.
14.65***Žq.
11.54***Žq.
8.26***Žq. 4.55***Žq.
3.53***Žq.
2.13**Žq.
1.97**Žy.
1.12 A Žq. indicates the sum of the coefﬁcients is positive and signiﬁcant, and a Žy. indicates the sum of the
coefﬁcients is negative and signiﬁcant.
***,**, and * indicate signiﬁcance at the 0.01, 0.05 and 0.10 levels, respectively. 176 CONTEMPORARY ECONOMIC POLICY average inﬂation uncertainty at the 0.01 level
of signiﬁcance. Therefore, we ﬁnd strong statistical support that higher average inﬂation
raises inﬂation uncertainty in Turkey over all
sample periods investigated.
Test results for whether inﬂation uncertainty lowers or raises subsequent inﬂation
are mixed. During the 1980 1998 period
ŽTable 2B., we found only limited evidence
of stabilizing behavior. Inﬂation uncertainty
lowers inﬂation at 4 and 12 lags at the 0.10
and 0.05 levels of signiﬁcance, respectively.
At 8, 16, and 24 lags we found no statistically
signiﬁcant relationship between inﬂation uncertainty and inﬂation.
Over the 1986 1998 period ŽTable 2C.,
we found evidence in the short run of the
opportunistic policy behavior. Inﬂation uncertainty is associated with signiﬁcantly Ž0.01
level. higher rates of inﬂation at four and
eight month lags. However, at longer lag
lengths of 12, 16, and 24 months, inﬂation
uncertainty signiﬁcantly Ž0.01 level. lowers
average inﬂation, indicating stabilizing behavior in the long run.
Similar results are found during the 1990s
ŽTable 2D., where inﬂation uncertainty ﬁrst
raises average inﬂation and then leads to
lower inﬂation in the long run. At lags of 4,
8, and 12 months during this period, inﬂation
uncertainty is associated with signiﬁcantly
higher inﬂation, indicating opportunistic
monetary policy behavior in the short run.
Evidence of stabilizing behavior is found in
the long run, since inﬂation uncertainty lowers average inﬂation after a 16 month lag.
V. POLICY DISCUSSION Our empirical results show that while inﬂation unambiguously raises inﬂation uncertainty in Turkey, the effect of inﬂation uncertainty on subsequent inﬂation depends on
the time period considered. In the full sample and in all subsamples, we ﬁnd at least
some evidence of monetary stabilization,
since increased inﬂation uncertainty always
leads to lower inﬂation, especially at longer
lags. We also ﬁnd some evidence of opportunistic central bank behavior at lags of a
year and less in the late 1980s and in the
1990s. This variation in monetary policy responses can perhaps be explained by changes
in the political and policy climate in Turkey
during this period. As depicted in Figure 1, inﬂation was relatively mild from 1960 until the mid 1970s
Žless than 20%. despite rising imported input
prices Ždue to the 1973 74 oil crisis. and
Turkey’s industrialization effort driven by
import substitution policies. Import substitution policies were largely funded by increased foreign exchange receipts and Central Bank ŽCB. credits to the public sector.
During this period, the CB relied on sterilization to lessen the expansionary effects of
public sector credits. This allowed a moderate monetary expansion and kept inﬂation
relatively low. However, toward the end of
the 1970s, inﬂation and inﬂation uncertainty
increased considerably as a result of a severe
foreign exchange shortage Ždue mainly to the
1973 74 oil crisis and declining export earnings., growing budget and current account
deﬁcits, and the debt crisis that followed. To
relieve the economy from rising inﬂationary
pressures, austerity measures were implemented in three consecutive years Ž1978,
1979, and 1980., but none of these International Monetary Fund supported measures
proved successful in lowering inﬂation variability.
Inﬂation did decline after the 1980 stabilization program Žsee Figure 1.. Contractionary monetary and ﬁscal policies lowered
inﬂation from 86% in 1980 to 30% in 1981.
A sharp increase in foreign currency inﬂows
as a result of restructuring of the external
debt also reduced the need for inﬂationary
ﬁnance. But then, in response to declining
GDP growth in 1983, monetary policy was
relaxed, and in the years that followed the
economy began to grow robustly, with inﬂation remaining stable at around 30% until
1986. The money supply also rose because of
the increase in the CB’s foreign assets due to
liberalization of the external trade and payments system.
Throughout most of the sample period,
CB policies were generally accommodative,
backing the government’s development and
industrialization policies and frequently
monetizing the ﬁscal deﬁcits that resulted.
Before 1986, the CB used publicsector credits and interest rates as monetary policy
instruments. The money supply was determined by total credit expansion, and monetary policy was directed toward controlling
private and public spending by setting borrowing limits for the banking system. After NAS & PERRY: INFLATION IN TURKEY 177 FIGURE 1
Inﬂation and Inﬂation Uncertainty, 1962 1997 1986, the CB took important steps toward
more autonomy by reorienting the monetary
process toward contemporary central bank
practices. A switch to monetary reserve targeting was accompanied by a series of new
legislation that allowed the CB to conduct
open market operations and monitor a newly
established interbank market. These reforms
were further complemented by accords with
the Treasury limiting the shortterm credits
that the government could use from the CB.
However, despite these measures that could
be interpreted as a move toward greater
central bank independence, inﬂation and inﬂation variability continued to surge after
1990.
As shown in Table 2, C and D, we found
evidence of the opportunistic central bank
behavior predicted by Cukierman and
Meltzer Ž1986. during this period of CB
transformation. For both the 1986 1998 and
1990 1998 subsample periods, inﬂation uncertainty is associated with signiﬁcantly
higher levels of inﬂation. This is somewhat interesting since the steps taken toward increased central bank autonomy after 1986
should have resulted in stabilization rather
than opportunistic behavior. One possible
explanation is that our test seems to capture
the policy motives of both ﬁscal and monetary authorities in Turkey rather than
speciﬁcally those of the CB. Note that the
policy response to inﬂation uncertainty in
Turkey should not necessarily be strictly considered in the framework of a stabilizing
central bank versus an opportunistic central
bank. Cukierman and Meltzer’s model makes
speciﬁc assumptions about Central Bank behavior, including a high degree of independence, which do not conform to many of the
unique features of the Turkey’s CB. Institutional arrangements allow the Treasury to
borrow from the CB and the CB to pursue
accommodative policies to ﬁnance public
deﬁcits. When it becomes necessary to disinﬂate, the Treasury usually coordinates its
efforts with the CB, and sometimes also with
the International Monetary Fund. 178 CONTEMPORARY ECONOMIC POLICY An assumption of Cukierman and Meltzer
Ž1986. that does ﬁt the Turkish situation is
that at times of increased political instability
there is more ambiguity about the conduct of
monetary policy and a high turnover rate of
central bank governors.8 For example, in an
effort to reinstate its credibility as an autonomous monetary authority, the CB had
announced a monetary program for 1990.
The CB initially met the stated monetary
targets, but during the years that followed,
political instability, a high turnover of CB
governors, and a rapid expansion of publicsector credits lowered the effectiveness of
the monetary program. Alternatively, the CB
tried to pursue an exchange rate stabilization
policy by controlling foreign reserves through
open market operations. By 1994 this led to
excessive growth of monetary aggregates, rising inﬂationary expectations, and higher interest rates.
Delays in stabilization in the early 1990s
also added to inﬂation and inﬂation uncertainty. Mounting macroeconomic problems
since the late 1980s heightened the need for
stabilization, but despite rising inﬂation and
deteriorating macroeconomic imbalances,
such efforts were delayed. A ‘‘war of attrition’’ between opposing political interests,
similar to that described in Alesina and
Drazen Ž1991., and reliance on increased
discretionary public expenditures as a way of
gaining political support were the main reasons for delays in stabilization Žsee Sayari,
1992, for details..
The coalition governments of this period
tried to disinﬂate while maintaining a high
rate of economic growth. Rather than implementing a credible stabilization package, the
coalition governments chose populist measures, such as maintaining an overvalued
Turkish lira, lowering interest rates, and 8. Cukierman Ž1992. conducts a comprehensive study
measuring central bank independence in 58 countries,
including Turkey. Much of the empirical evidence on
Turkey’s Central Bank independence reported by
Cukierman conﬁrms our discussion here. For example,
Turkey’s turnover rate of Central Bank governors between 1950 and 1989 is 5th highest out of 58 countries.
In another ranking of overall central bank independence in the 1980s, Turkey ranks 42nd out of 46 countries, when the countries are ranked from most independent to least independent. strategically adjusting the prices of a wide
range of goods and services produced by the
state economic enterprises. In view of rising
publicsector borrowing requirements, these
measures proved unsustainable, and the CB
failed on numerous occasions to meet its
monetary targets. Consequently, the ﬁnancial crisis of 1994 ensued, which led to the
implementation of a stabilization program
later in the same year.
After a short period of monetary and ﬁscal tightening, economic growth resumed in
1995. Inﬂation, after dropping from its alltime high level in 1994 to 72% in 1995,
gradually began to rise as upward price adjustments in the public sector followed. Publicsector borrowing requirements continued
to increase as well. And as efforts to lower
the Treasury’s reliance on CB resources began to show a sign of weakening, the Treasury and CB once again agreed to coordinate
their efforts, this time to target inﬂation.
Early data show that the strategy seemed to
work, despite remaining concerns about the
budget deﬁcit and the unsettled issue of CB
autonomy.
From this examination of Turkey’s disinﬂation experiment it is clear that the CB is
not independent of macroeconomic policy
making. Stabilizing behavior, or the lack of
it, is the responsibility of both the ﬁscal and
monetary authorities. And for the most part,
consistent with Sargent and Wallace’s Ž1981.
coordination scheme between the ﬁscal and
monetary authorities, the ﬁscal authority in
Turkey appears to have the upper hand. The
ﬁscal authority has even more inﬂuence on
monetary policy during periods of high
turnover of coalition governments. For example, during the 1983 86 politically stable
period, inﬂation and inﬂation variability remained relatively low, but frequent elections
and governments that followed after 1987
led to an expanding budget that increasingly
relied on CB resources.
It is also clear that central bank independence can accomplish little without ﬁscal
discipline. If Turkey is to become a singledigit inﬂation country, it seems almost imperative that the ﬁscal authority seriously
consider ways to move away from inﬂationary bias. Then, it may be possible for the CB,
as an autonomous entity, to stabilize the
economy through sound monetary polices. NAS & PERRY: INFLATION IN TURKEY True, the CBTreasury alliance has attempted and to some extent succeeded in
putting downward pressure on inﬂation, especially during the 1980 1987 period. But
throughout the full sample period and particularly during the 1990s, inﬂation stabilization not only increasingly suffered from the
problem of time inconsistency but also failed
to produce a ﬁscal environment that would
allow the CB to practice its autonomy.9
VI. CONCLUSION The results of this study conﬁrm the predictions made by Friedman Ž1977. and Ball
Ž1992. about the relationship between inﬂation and inﬂation uncertainty. We ﬁnd overwhelming statistical evidence that increased
inﬂation signiﬁcantly raises inﬂation uncertainty in Turkey between 1960 and 1998 and
in three subsamples. The evidence on the
effect of inﬂation uncertainty on average inﬂation is mixed and depends on the time
period examined. Over the full sample period, increased inﬂation uncertainty is associated with lower average inﬂation at all lags.
In the two subsample periods that cover the
last half of the 1980s and the 1990s, inﬂation
uncertainty raises average inﬂation over lags
of a year and less. During those periods,
increased inﬂation uncertainty leads to lower
inﬂation at longer lags of between 12 and 24
months. Thus, stabilizing policy behavior
seems to prevail overall, especially in the
long run, but opportunistic behavior is evident in the short run in the later subsample
periods.
An analysis of the political environment
in Turkey between 1960 and 1998 generally
supports our empirical results. Over the full
sample period, Turkey’s ﬁscal and monetary
authorities appear to be generally spending a
concerted effort to disinﬂate, which is consistent with our empirical ﬁndings of stabilizing 179 behavior overall. While the attempts to stabilize inﬂation seemed to work during the politically stable periods of the early 1980s, the
political instability that we document in the
late 1980s and the 1990s resulted in opportunistic policy behavior. We speculate that
the problems of time inconsistency, the lack
of ﬁscal discipline, a high turnover of Central
Bank governors, and politically motivated
monetary expansions were all contributing
factors that led to opportunistic behavior
and subsequently to periods of high inﬂation
and inﬂation uncertainty. A move toward
greater central bank independence in Turkey
could help mitigate some of these outcomes
in the future by creating an institutional
framework that would reduce opportunistic
behavior and increase the possibility that
monetary stability would prevail. Also, further research on Turkish inﬂation could help
determine whether inﬂation uncertainty has
affected real output growth during this period of chronically high inﬂation. REFERENCES
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