Mehmet Yörükoğlu Deputy Governor 2013 Central Bank Macroeconomic Modelling Workshop

1. Monetary Policy Modelling: New Directions“Practice is ahead of theory, theory is ahead of modelling ...” Erdem Başcı Mehmet Yörükoğlu Deputy Governor 2013 Central Bank Macroeconomic Modelling Workshop November 7-8 2013, Istanbul

2. Contents The changing role of monetary policy in the pre and post-crisis period Changes in monetary policy modelling approach Turkish experience

3. The redesign of monetary policy strategy Challengingquestions: • How will monetary policy objectives and policy tools evolve? • How will financial stability considerations be integrated into the policy process? • What changes to the policy framework will be adopted? 3

4. Pre-crisis consensus • Commitment to a strong nominal anchor • Inflation targeting • Main objective: price stability • Single instrument: interest rate • Subsidiary role for the financial system

5. Need for a new monetary policy framework Why a new policy framework? • New role for central banks: avoid development of financial imbalances • The post-crisis economic environment is different • Unconventional policy instruments

6. Decoupling • The traditional monetary policy framework was embraced by both emerging and developed countries • The crisis created a decoupling • Problems and policy responses differed among developed and emerging economies.

7. Crisis experience: Developed countries Problems • sharp decline in growth, • deflationary pressures, • liquidity problems. • large-scale balance sheet policies, • provision of ample liquidity, • buying risky assets, • forward guidance... Measures

8. Crisis experience: Emerging economies Problems • volatile cross-border capital flows, • exchange rate appreciation, • rapid credit growth. • increasing bank reserve requirements, • restrictions on credit market, • taxing capital flows... Measures

9. Capital flows Financial Instability Cycle for an Emerging Market Economy Improvement in Risk Perceptions CapitalInflows Currencyappreciation Easierexternalfinance ExternalBorrowing Balancesheeteffectsandeasingcreditstandards • Capital flows affect economy significantly mainly through credit and exchange rate channels.

10. Turkish Experience

11. Financial Stability Concerns: Credit Growth Total Loan Growth Rates (13 Weeks Moving Average, Annualized, FX Adjusted, Percent) Source: CBRT. • Fast credit growth... 11

12. Financial Stability Concerns: Current Account Current Account Balance (Seasonally Adjusted, Quarterly Average, Billion USD ) Main Sources of Current Account Deficit Finance* (12-monthsCumulative, Billion USD) *Short-term capital movements are sum of banking and real sectors' short term net credit and deposits in banks.Long-term capital movements are sum of banking and real sectors’ long term net credit and bonds issued by banks and the Treasury. Source: CBRT. Source: TURKSTAT, CBRT. • Current account deficit widened significantly • Most of CA deficit was financed by short-term capital flows

13. Financial Stability Concerns: Exchange Rates TL and Other EM Currencies Against USD (9March 2009=1) Real Exchange Rates (ReR) in Turkey (2003=100, Logarithmic scale, Reverse order) EM countries are Brazil, Chile, Colombia, Czech Republic, Hungary, India, Indonesia, Malaysia, Mexico, Morocco, Peru, Philippines, Poland, Russia, South Africa, South Korea, Taiwan and Thailand. Source: Bloomberg, CBRT. • Nominal currency appreciated around 20 percent, moving together with other EM currencies • Real exchangeratesappreciatedsignificantlycomparedtoitslong-term trend

14. Modification of inflation targeting regime • Adopting financial stability as a supplementary objective. • Enriching the set of policy instruments: • wide assymmetric interest rate corridor, • reserve option mechanism.

15. Interest Rate Corridor

16. Reserve Option Mechanism Reserve Option Coefficients Use of the ROM Source: CBRT.

17. Results: Credit growth Total Credit Growth (%) • Creditgrowth is contained.

18. Results: Current Account Current Account Balance (12-month Cumulative, Billion USD ) Main Sources of Current Account Deficit Finance* (12-monthsCumulative, Billion USD) *Short-term capital movements are sum of banking and real sectors' short term net credit and deposits in banks.Long-term capital movements are sum of banking and real sectors’ long term net credit and bonds issued by banks and the Treasury. Source: TURKSTAT, CBRT. Source: TURKSTAT, CBRT. • Significant improvement both in the level and financing of the current account deficit.

19. Results: Exchange Rate TL and Other EM Currencies Against USD (1November 2010=1) Implied FX Volatility (1-month) EM Currencies (with 20%-80% bandaroundthemean) Turkey • Correction of theinitialovervaluation in thecurrency. • Lowvolatility of currencyrelativetopeeremergingcountries.

20. Overview • Practice is ahead of theory; theory is ahead of modelling ... • Incorporating financial stability along with the price stability, and a better management of global spill-overs • The crisis stimulated research on incorpotating the interactions between financial market imperfections and the real economy in policy models. • To understand the transmission of unconventional policies empirically, future research should continue to exploit the experience of central banks in the last five years.

21. Thank You. Mehmet Yörükoğlu Deputy Governor 2013 Central Bank Macroeconomic Modelling Workshop November 8, 2013, Istanbul