Mustafa Kilinc

Resilience of the Turkish Economy During the Global Financial Crisis of 2008

The authors explore the sources of the resilience of the Turkish economy to the global financial crisis of 2008. They first show that financial factors and fundamentals were very strong in Turkey before the crisis, and monetary and fiscal policies responded strongly to the crisis in a countercyclical way. They find that these strong fundamentals and prudent economic policies are reflected in the risk premium movements. Emerging market bond index (EMBI) spreads for Turkey increased slightly during the 2008 crisis and decreased back to the normal levels quickly. This was in large contrast to the crisis in 2001, when spreads increased significantly due to the weak fundamentals and decreased very slowly. Second, the authors quantitatively analyze the effects of risk premium movements during the crisis in a small open economy framework. They find that the risk premium observed in 2008 could not generate large movements in output, validating the point that the Turkish economy was resistant to the financial factors of the crisis.

MACROPRUDENTIAL POLICIES AS BUFFER AGAINST VOLATILE CROSS-BORDER CAPITAL FLOWS

This paper investigates the effectiveness of macroprudential policies introduced by Turkey in late 2010. The unprecedented quantitative easing policies of advanced countries after the global financial crisis have presented serious financial stability concerns for most emerging countries including Turkey. To cope with these challenges, Turkey has devised new policy tools such as asymmetric interest rate corridor and reserve option mechanism. From the perspective of capital flows, the interest rate corridor works mainly through stabilizing supply of foreign funds, and the reserve option mechanism through decreasing the sensitivity of equilibrium exchange rate to shifts in the demand for foreign funds. Using a large panel of 46 countries and employing [Bruno and Shin (2013a). Capital flows, cross-border banking and Global liquidity. Working paper, Princeton university; Bruno and Shin (2013b). Assessing macroprudential policies: Case of Korea. Working paper, Princeton university] methodology, we investigate whether the new policy framework in Turkey has been successful in cushioning the economy from volatile cross-border capital flows from a comparative perspective. The results show that, after controlling for a set of domestic and external variables and relative to a group of advanced and emerging countries, cross-border capital flows to Turkey have been less sensitive to global factors after the implementation of macroprudential policies.

Trend Shocks, Risk Sharing and Cross-Country Portfolio Holdings

This paper analyzes the dynamics of risk premia, real exchange rates and portfolio movements in a two-country, two-good, two-bond model. We use an asymmetric set-up in the model, where one of the countries is emerging and the other one is developed and both countries issue bonds in domestic currency. The emerging country differs from the developed country in that it is subject to trend shocks and it is more risk averse. We find that the trend shocks produce strong wealth effects for the emerging country, and as a result, the terms of trade and the real exchange rate appreciate. Appreciation of the terms of trade breaks the hedging opportunities coming from international trade in goods. In contrast, the appreciation of the real exchange rate generates new hedging opportunities in international financial markets for both countries. Therefore, our model can endogenously generate large portfolio holdings. And differences in the risk aversion across countries lead to net positive foreign asset positions and significant risk premia in the emerging country. Moreover, the relative volatilities and cyclicalities of risk premia and real exchange rates improve significantly and move closer to the observed values in the data and our model can account for the lack of international risk sharing.

EXCHANGE RATE PASS-THROUGH IN A SMALL OPEN ECONOMY: A STRUCTURAL VAR APPROACH: Exchange Rate Pass-Through in a Small Open Economy

Pass through from the exchange rate developments to consumer prices could be an important dimension of inflationary dynamics in small open economies. In such economies, the proper identification of exchange rate pass through (ERPT) is crucial for monetary policy analysis. In this paper, we study ERPT in Turkey for the period of 2006m1-2015m6, which starts with the launch of explicit inflation-targeting regime. We first show that commonly used recursive VAR model generates unrealistic dynamics like effects of domestic variables on external variables in small open economies and as result ERPT estimate is biased. This bias comes from the unrealistic decline in energy prices in response to depreciation of currency for the given period in Turkey. We then use a structural VAR model with block exogeneity assumption. This model generates more realistic dynamics and suggests that ERPT is around 18 percent in Turkey. Overall, the analysis demonstrates the importance of using realistic model setup and checking the relationships across variables when estimating ERPT in small open economies.