Exchange Rate Pass-Through in Turkey Before and After the Adoption of Inflation Targeting Regime

Transcription

1 DOI: /FAI No. 2/2017 Exchange Rae Pass-Through in Turkey Before and Afer he Adopion of Inflaion Targeing Regime Özcan Karahan Bandırma Onyedi Eylül Universiy Faculy of Economics and Adminisraive Sciences Bandırma / Balıkesir okarahan@bandirma.edu.r Absrac: The impac of exchange rae change on he domesic price level which is called as exchange rae pass hrough has long been of ineres in inernaional economics lieraure. Along wih he applicaion of inflaion argeing regime widely, he focus of his ineres has also evolved o examine he changes in degree and speed of exchange rae pass hrough under inflaion argeing regime. Turkey, adoped Inflaion Targeing (IT) as a moneary regime beween 2001 and 2006 implicily and hen explicily, exhibis which was a genuine experience o be analyzed in his respec. From his poin of view, he goal of he sudy is o provide a ime-series analysis of exchange rae pass-hrough for Turkish economy based on single equaion Error Correcion Model esimaion using he monhly daa under pre-it period and pos-it period Thus, we ry o clarify he effeciveness of inflaion argeing regime as moneary policy on he exchange rae pass-hrough. The findings of he sudy indicae ha he exchange rae pass-hrough decreased in he pos-it period compared o pre- IT period. Accordingly, i can be argued ha he implicaion of inflaion argeing regime reduced exchange rae pass hrough in Turkey. Keywords: error correcion model, exchange rae pass-hrough, inflaion argeing JEL codes: E31, E58, F31, C22 Inroducion Along wih increasing globalizaion, inernaional financial and business relaionships grow dramaically, which lead he exchange rae o be one of he mos significan macroeconomic facors. In his conex, large flucuaions in nominal exchange raes have also become very imporan from he perspecives of policy acions aiming a macroeconomic sabiliy. Therefore, dynamics of exchange rae and is relaionships wih oher macroeconomic variables need o be undersood inensively. Accordingly, undersanding he impacs of exchange rae changes on oher macroeconomic variables has been he main focus of inernaional economics lieraure recenly. In his lieraure, i appears ha sudies examining he impac of changes in exchange rae on domesic price level, called as Exchange Rae Pass Through (ERPT) has a big share. In fac, he number of sudies focusing on ERPT remendously has grown over las decades. Along wih he growing ineres on he ERPT, i also seems ha an imporan number of empirical sudies have recenly deal wih he impac of inflaion argeing regime on ERPT. Along wih he adopion of inflaion argeing regime many counries have 37

2 reached low and sable inflaion levels. In connecion wih his process analysing, he impac of inflaion argeing regime on ERPT becomes a significan research agenda for he economiss. The empirical evidences mosly sugges ha he degree of passhrough decreases along wih he implicaions of inflaion argeing. Afer adoping Inflaion Targeing as a moneary regime in 2006 explicily, accompanied by an increase in he ransparency of moneary policy, Turkish economy has also embarked ino a process of diminishing inflaion. Accordingly, he crucial research quesion here is wheher he lower he inflaion rae under inflaion argeing regime caused he weaker he exchange rae pass hrough in Turkey. From he saring poin of consideraion above, his aricle aims o examine he impac of he changes in nominal exchange raes and domesic prices in Turkey by using of Error Correcion Model over wo differen periods; he pre-inflaion Targeing period beween 1995 and 2000 and Pos-inflaion Targeing period beween 2006 and Thus, we ry o invesigae how changes in he exchange rae were ransmied o he consumer prices in Turkey afer adoping Inflaion Targeing Regime explicily in 2006 compared o previous era. By examining he Turkish case, we aim o shed some more ligh on he ransmission mechanism from exchange raes o prices under inflaion argeing regime. Our paper is organised as follows. Following he inroducion above, he second par describes he mehodology and daa. The hird secion presens empirical resuls and includes some discussion on he relaionship beween exchange rae pass hrough process and implemenaion of inflaion argeing regime. The final secion concludes and suggess some policy implicaions. 1 Lieraure Review Exchange rae flucuaion passed hrough o domesic price which is called as exchange rae pass-hrough effec has long been of ineres in he inernaional macroeconomics lieraure. The impac of exchange rae shock on price level operaes in a complex ransmission mechanism depending on many facors. Accordingly, separae esimaions of he ERPT have o be conduced for differen ways in he lieraure. However, generally speaking, i can indicae wo channels hrough which changes in he exchange rae are passed on o consumer prices direcly and indirecly. In he end, we can explain he ERPT process by considering direc and indirec effecs of he exchange rae changes on domesic price levels like below (Aliyu e. al. 2009; 7-8). The direc channel is relaed o he impac of exchange rae fluacions on domesic price level via impor prices. According o his, imporers increase heir prices in he local currency o mainain heir markups while local currency depreciaes afer an increase in he nominal exchange rae. Thus, consumers have o pay much more in he local currency o purchase he same impored consumpion goods. On he oher hand, if he manufacuring secor depends on impored inpus ha are priced in a foreign currency, hen depreciaion of local currency resuls in an increase in he producion cos of manufacuring secor. In connecion wih ha, local producers charge consumers higher prices in order o mainain heir markups. Thus, iniial depreciaion of local currency causes an increase in he consumer prices. The 38

3 magniude of his kind of pass-hrough is ighly relaed o he dependency of local producion on impored inpus ha are priced in foreign currency. To sum up, imporers change heir prices of impored consumer and producer goods proporionally wih he shif in he exchange raes and hus ransfer fluacions in he exchange raes o domesic price level. The indirec channel is relaed o he effec of exchange rae fluacions on he amoun of oal demand and in he level of wages. If he exchange rae increases, he impors become more expensive for domesic buyers. This leads o a higher demand for subsiue domesic producs by domesic consumers. On he oher hand, demand for expors rises while he exchange rae increases since he domesic producs become relaively cheaper for foreign buyers. This also leads o a higher demand for domesic producion by foreign buyers. In conclusion, depreciaion of local currency causes increasing oal demand via a higher demand for impor subsiue goods by domesic buyers and for expors by foreign buyers. This increase in he oal demand, of course, pushes he domesic price level up. Furhermore, he increasing demand for domesic producs evenually leads o a higher producion and herefore a higher demand for labour, which can be followed by an increase in wages. This increase resuls in furher upward pressure on he domesic prices. When we examine he lieraure, i seems ha sudies seraching he exchange rae pass-hrough previously focus only on he link beween exchange rae and impor prices. Thus, previous sudies mosly concenrae on exchange rae flucuaion passed hrough o impor prices (Swamy and Thurman 1994; Webber 1999; Campa and Goldberg 2002; Barhoumi 2006). In deail, he exchange rae affecs domesic consumer prices hrough prices of impored consumer goods and he price of impored inpus used in domesic producion. To pu i anoher way, exchange rae movemens affec domesic consumer prices via eiher direcly prices of impored consumpion goods or indirecly prices of impored inermediae goods. Subsequenly, much of he research deals wih he relaionship beween movemens in exchange rae and producer and consumer prices (Takhamanova 2010; Ocran 2010; Ahn and Park 2014). Some sudies in he lieraure also focus on he macro drivers of he exchange rae pass-hrough. They indicae he facors like exchange rae and inflaion volailiy, impor dependence, oupu gap, price ineria, currency subsiuion and expecaions as he basic drivers of exchange rae pass-hrough (Choudhri and Hakura 2001; Carranza e. al. 2009; Jimborean 2013). Recenly, i also seems ha large body of lieraure devoed o examine he link beween he effeciveness of moneary policies adoped in he framework of inflaion argeing regime and he exchange rae pass-hrough process. The findings of empirical sudies generally argued ha he low inflaion environmen recenly achieved in many counries afer adoped inflaion argeing regime causes a decline in he impac of exchange rae on domesic prices. Thus, afer he adopion of he inflaion arge regime, he pass-hrough effec seems o be diminished in he mos of he counries. In his conex, Reyes (2007) uses he simulaions for he pass hrough effec analysis under wo moneary regimes crawling peg and inflaion argeing. 39

4 Rolling Windows Correlaion mehodology based on sochasic simulaed daa shows ha declining pass rough effecs in Brazil, Chile and Mexico are resuls of changes in moneary policy regimes, a swich from a crawling peg regime o an inflaion argeing regime. Thus, i is also indicaed ha he nominal exchange rae effecs on he overall inflaion rae may no longer be an issue for emerging economies implemening inflaion argeing policy. Odria e al (2012) ries o analyse wheher he exchange rae pass-hrough ino prices changed when he inflaion argeing scheme was adoped in Peru beween 1994 and In he framework of a vecor smooh ransiion auoregressive model (VSTAR), analysis of he generalized impulse response funcions reveals ha he decision o adop inflaion argeing significanly decreased he exchange rae pass-hrough ino producer and consumer prices. Thus, hey indicae ha adoping inflaion argeing generaes a pass-hrough conracion. Looking a he European area, Beirne and Bijserbosch (2011) assess he degree of exchange rae pass hrough o consumer prices using boh a mulivariae coinegraion approach and impulse responses derived from he VECM for nine cenral and easern EU Member Saes based on monhly daa from 1995 o They find noable differences across counries wih fixed exchange rae regimes compared o hose wih more flexible regimes. Accordingly, while for he four fixed exchange rae counries such as Bulgaria, Esonia, Lavia and Lihuania, a hypohesis es for full pass-hrough canno be rejeced, for he counries wih more flexible regimes like he Czech Republic, Hungary, Poland, Romania and Slovakia, full pass-hrough is rejeced in all cases. Concerning wih he sudies focusing on Turkey, Volkan e al (2007) also ry o deermine if here has been a change in he magniude of exchange rae passes hrough for he periods, when he exchange raes were allowed o floa under inflaion argeing regime. Their findings indicae ha exchange rae pass hrough has declined for he pos-2003 period by nearly one-half compared o he pre period. In addiion, he decline in he exchange rae pass-hrough impac on domesic prices coincides wih a 25 percen decline in he pos-2003 consumer price inflaion. Anoher evidence of declining exchange rae pass-hrough in he Turkish economy afer he adopion of an inflaion-argeing regime is offered by Kara and Öğünç (2008). They employed he VAR mehodology and examined he exchange rae pass-hrough before and afer he implicaion of inflaion argeing. Empirical resuls show ha exchange rae pass-hrough has weakened since he adopion of inflaion argeing regime in They also argued ha his finding is due mainly enhanced credibiliy of he cenral bank acquired by he implemenaion of a successful inflaion argeing regime. More recenly, Dedeoğlu and Kaya (2014) employ a rolling VAR framework o examine exchange rae pass hrough over he period beween 1995 and 2012 in Turkey. They find ha he exchange rae pass-hrough has declined sharply afer he adopion of inflaion argeing regime. The larger impac of exchange rae pass hrough on he producer prices compared o consumer prices upwards in he inflaion argeing regime. Overall, hey indicae ha he disinflaion period and he implemenaion of 40

5 he inflaion argeing regime appears o play a significan role in he dynamics of exchange rae pass hrough in Turkey. Arslaner e. al. (2014) also quaniaively analyse exchange rae pass- hrough beween 1986 and 2013 by using vecor auoregressions (VAR) and Markov swiching regression mehods. The higher degree of exchange rae pass-hrough is found in Turkey. However, i is observed ha exchange rae pass hrough subsanially decreases during he implicaion of inflaion argeing regime compared o pre-inflaion argeing regime. They also find ha exchange rae pass-hrough for producer price-index-based inflaion is higher han for consumerprice-index-based inflaion. Conrary o findings presened he sudies relaing Turkey above, Civcir and Akçağlayan (2010) prominenly argue ha he main channel in feeding he inflaion in Turkey is he depreciaion of he domesic currency even under inflaion argeing alhough exchange rae pass hrough weakened and slowed compared o is degree in crawling peg sysem. They analyse he exchange rae pass hrough and moneary policy reacion funcion of he Cenral Bank of Republic of Turkey over he wo differen periods before inflaion argeing ( ) and afer inflaion argeing ( ). Using VAR model, hey show ha here has been srong pass-hrough during whole period while exchange rae has also been he main reacion variable for he Cenral Bank. Thus, hey also argue ha, Cenral Bank, aking ino accoun of presence of higher level exchange rae pass hrough, sill inervenes in he foreign exchange rae markes agains o emporary flucuaions even during he inflaion argeing period. As can be seen from he review of sudies focusing on Turkish case, i has been widely documened ha he exchange rae pass-hrough o domesic inflaion has decreased afer adapaion of inflaion argeing regime. Furhermore, exising empirical sudies esimaing he impac of inflaion argeing regime on exchange rae pass-hrough for Turkish Economy are based on eiher single equaion esimaion or VAR models. We will use an alernaive esimaion mehod, namely vecor error correcion (VEC) model since evidence of he exchange rae pass-hrough based on VEC model is scarce in Turkey. In his way, we conribue o he exising evidence on he ransmission mechanism from exchange raes o prices under inflaion argeing regime by using an alernaive esimaion mehod. Thus, i will be ineresing o compare he resuls from his paper model wih he resuls of previous sudies using VAR model o analyse exchange rae pass-hrough in Turkey. 2 Daa and Mehodology We use wo basic daa se including nominal exchange rae and consumer prices while we explore he exchange rae pass hrough in Turkey over he period pre-inflaion Targeing (IT) regime beween 1995 and 2000 and pos-it regime beween 2006 and Accordingly, he daa se consis of monhly observaion of TL/USD nominal exchange rae (ER) and consumer prices (CP) covering he periods, pre-inflaionargeing ( ) and inflaion-argeing ( ) periods. We do no consider he erm beween 2001 and 2005 since his erm is a ransiion period o inflaion argeing and inflaion argeing has only been applied implicily in his 41

6 process. All of he daa have been obained from he daa base of Cenral Bank of Turkey (CBRT). Looking a he economeric approach used in relaed lieraure, i seems ha he empirical papers mosly employ he mehodologies based on single equaion model and vecor auoregressive (VAR) model inroduced by Chrisopher Sims (1972). In his sudy, we apply coinegraion analysis including vecor error correcion (VEC) model inroduced by Engle and Granger (1987) in order o examine he exchange rae passhrough. Compared o single equaion model and VAR model, VEC model presens wo significan advanages in order o analyse he process of exchange rae pass-hrough. Firsly, coefficien of he error correcion erm esimaed in his model can be inerpreed as he disequilibrium response of prices o exchange rae shocks, which means speed of exchange rae pass hrough. Secondly, his model le us o esimae he long run sable relaionship beween exchange rae and price level which shows he degree of exchange rae pass hrough. To sum up, VEC model is he appropriae esimaion ool for providing significan advanage o esimae he degree and speed of exchange rae pass hrough ogeher. Thus, VEC model has he advanage of incorporaing shor-run dynamic wihou disregarding long-run equilibrium relaions beween exchange rae and price level. In order conduc an VEC model, one can sar wih a bivariae auoregressive disribued lag model such ha he curren value of he y is a funcion of is own pas value and curren and pas value of x (Thomas, 1993, p. 153). In his equaion, C symbolizes inercep while shows whie noise error erms. y C x x y (1) subracing y 1 o boh sides of he Equaion (1) yields y C x x (1 ) y (2) adding and subracing 1x 1 o righ side of he Equaion (2); y C x x x x (1 ) y y C x ( ) x (1 ) y y C x (1 )( y x re-arranging Equaion (3) in erms of (1 ) and ; y C x ( y x ) (4) y x ( y C x ) (3) 42

7 finally re-arranging in erms = 1 C ; y x ( y x ) (5) where (Y-1 - μ - δ X-1) express long run relaionship beween X and Y. Accordingly, δ means he coefficien of long run equilibrium relaionship which shows he degree of exchange rae pass hrough. The coefficien of λ refers o he speed of adjusmen of shor run disequilibrium o long run equilibrium beween Y and X. To pu i anoher way, he value of coefficien λ ells us wha rae i correcs he previous period disequilibrium of he sysem. When λ is significan and conains negaive sign, i validaes ha here exiss a long run equilibrium relaionship among variables Y and X. The coefficien of β represens an immediae or shor run effec of X on Y. Thus, he coefficien β1 indicaes he effec of he change in X on he change in Y, of which will be helpful o know shor run dynamics of he sysem. Consequenly, he change in Y as a funcion of he change in X plus an error correcion erm, where β1 describes he shor-run relaionship and λ he speed of adjusmen o he long run equilibrium. As can be seen in he explanaion above VEC model has he advanage of yielding an esimae for he degree and speed of exchange rae pass hrough. Accordingly, ECM given by Equaion 5 will be esimaed separaely for boh erm s consumer prices, preinflaion-argeing ( ) and pos-inflaion argeing ( ) periods. Thus, we will ry o esimae he long erm pass hrough (δ) as well as he speed (λ) a which he prices indices adjus o a change in he exchange raes for boh erms. 3 Resuls and Discussion In his secion, based on single equaion Error Correcion Model, we empirically analyse he exchange rae-pass hrough pre-inflaion argeing period and posinflaion argeing period in Turkey. Firs of all, we check wheher our ime series are saionary a same level or no since coinegraing necessiaes ha he variables be inegraed of he same order. Coinegraed variables only have a buil in error correcion mechanism and subsequenly coinegraing necessiaes ha he variables be inegraed of he same order. Thus, before seing up he coinegraion analysis and error correcion model, we sar wih he deermining he order of inegraion for boh of he variables Consumer Prices (CP) and Exchange Rae (ER). The resuls of Augmened Dickey-Fuller (ADF) es in Table 1 sugges ha nonsaionary canno be rejeced for he levels of variables. In conras, when he daa are differenced, non-saionary can be rejeced in all variables. Thus, boh of he variables Consumer Prices (CP) and Exchange Rae (ER) appear o conain a single uni roo which cancels ou on firs differencing. Thus, hey clearly appear o be I (1) in boh pre-inflaion argeing period and pos-inflaion argeing period. Afer deermined ha all of he variables are I(1) for boh periods, a simple OLS regression indicaed in Model 1 also runs on he levels of each variable for boh periods again. 43

8 C P ER u (Model 1) Table 1 Augmened Dickey-Fuller uni roo es CP ER Variables Pre-IT period Pos-IT period Levels Firs Differ. Levels Firs Differ (0.230) (0.000)* (0.310) (0.000)* (0.410) (0.000)* (0.410) (0.000)* Noe: p-values in parenhesis; (*) indicaes significance a he 1 percen level. where CP and ER are non-saionary variables and u is he residual. Afer esimaion of he long run relaionship in Model 1 by using OLS for boh erms, coinegraion can be esed using ADF-ype uni roo ess on he residuals (u ) by esing he null hypohesis of non-saionary of he residuals (u ). As can be shown in Table 2, resuls of uni roo ess for residuals performed by ADF assers ha he null hypohesis of non-saionary of he residuals is rejeced, which indicaes ha here is a coinegraion beween CP and ER for boh erms. Level Table 2 Augmened Dickey-Fuller ess for he residuals Pre-IT period Pos-IT period (0.000)* Order of inegraion I(0) Level (0.000)* Order of inegraion Noe: p-values in parenhesis; (*) indicaes significance a he 1 percen level. I(0) As he variables such as CP and ER are coinegraed for wo erms, we hen can run he error correcion model (ECM). Accordingly, he ECM given by Equaion 5 has been esimaed in he form of Model 2 below for boh erm s consumer prices separaely. CP 1 ER ( CP 1 ER 1) (Model 2) Where δ shows he long run relaionship beween consumer prices (CP) and exchange rae (ER) and hence degree of exchange rae pass hrough; λ refers o he speed of adjusmen of shor run disequilibrium o long run equilibrium beween consumer prices (CP) and exchange rae (ER) and hence speed of exchange rae pass hrough. Esimaion resuls of ECM indicaed Model 2 for boh erms daa is presened in Table 3. For wo erms, explanaory power of he models (Adj R 2 ) and he saisical significance of heir regression coefficiens (δ and λ) are appropriae. Resuls of he Breusch-Godfrey LM Tes and Whie es also indicae ha here is no serial correlaion and no heeroscedasiciy, respecively. The esimaed resuls of he degree of 44

9 exchange rae pass hrough (δ) as well as he speed a which he prices indices adjus o a change in he exchange raes (λ) are also presened in Table 3. Speed of pass hrough or he coefficien of error correcing erm (λ) in ECM esimaion appears wih he expeced negaive coefficien, which is significanly differen from zero a he 5 percen level for boh periods. Thus, empirical resuls suppor he accepance of coinegraion or he validiy of long run equilibrium relaionship beween CP and ER or exchange rae passes hrough for boh erms. Consequenly, afer deerminaion he coinegraion beween exchange rae and consumer prices by using ADF Tes for residuals in Table 2, we also indicaed again his fac wih he resuls of error correcion model. Besides, he coefficien of speed of adjusmen are and percen meaning ha sysem correcs is previous period disequilibrium a a speed of and 9.10 percen monhly for pre-it and pos-it period, respecively. Looking a he degree of long erm pass-hrough (δ), alhough hey seem o be saisically significan for boh erms, he values of coefficiens are in he firs erm and in he second erm. This means ha, in he long run, a change in he exchange rae is poorly ransmied o he consumer prices in pos-it period compared o pre-it period. Given he fac ha δ symbolizes complee exchange rae pass hrough when i equals one (δ =1), i can be furher assered ha exchange rae pas hrough for boh erms are incomplee. Degree of pass-hrough ( ) Speed of pass-hrough ( ) Table 3 Error correcion model esimaion Pre-IT period (0.013) ** (0.014) ** Pos-IT period (0.031)** (0.021)** Co-inegraion Relaion Yes Yes Complee pass hrough No No Adj R Breusch-Godfrey LM Tes (0.201) (0.241) Whie Tes (0.178) (0.271) Noe: p-value in parenheses, (**) indicaes significance a he 5 percen level. The findings of he sudy indicae ha he pass-hrough effec dramaically reduce in pos-it period ( ) wih he inroducion of he inflaion argeing pracices. In oher words, we indicae a decline in he exchange rae pass-hrough along wih he implicaions of inflaion argeing regime. Our findings are consisen wih previous invesigaion of he exchange rae pass-hrough under inflaion argeing regime for Turkey (Volkan e. al 2007; Kara and Öğünç 2008; Dedeoğlu and Kaya 2014; Arslaner e. al 2014). However, alhough previous sudies have mosly relied on single equaion or VAR models o esimae he exchange rae pass-hrough, we use VEC model since his mehodology is more suiable o capure he dynamics of he exchange rae pass- 45

10 hrough. Thus, we provide furher evidence in suppor of same claim for Turkish economy by using alernaive esimaion mehod, namely VEC model. I is clear ha under inflaion argeing regime low and more sable inflaion rae leads o a decrease in he pass-hrough in Turkey. Indeed, recen reducion in he exchange rae pass-hrough can be aribued in he low-inflaion environmen provided inflaion argeing regime. This fac can be arisen from several reasons in he implemenaion of inflaion argeing regime. The increase in he ransparency of moneary policy may raise he credibiliy of he cenral bank regarding he prospecs of disinflaion and hence lower exchange rae volailiy. The effecs of price sabiliy may also be refleced by he decrease in he risk premium included in he exchanges raes charged by economic agens. Besides decreasing impacs of inflaion argeing regime on exchange rae pass hrough, i should also be noed ha lower pass-hrough can be more advanageous for cenral bank adoped inflaion argeing regime. The lower he exen of passhrough he larger will be he effeciveness of cenral bank s policies. A low level of pass-hrough is beneficial because he high level exchange rae pass hrough decrease he flexibiliy of cenral bank for seing inflaion arge. Thus, on he one hand, he degree of exchange rae pass-hrough ino inflaion is imporan for he effeciveness of inflaion argeing regime. Bu on he oher hand inflaion argeing regime is also he major deerminans of he weaker exchange rae pass hrough process. In conclusion, his posiive muual ineracion beween weak exchange rae pass hrough and effecive inflaion argeing regime may be a he roo of developmens in pos-it erm for Turkish economy. Conclusions The purpose of his paper is o evaluae he effecs of he adopion of an inflaion argeing regime on he exchange rae pass-hrough in Turkey. Accordingly, we examine he impac of fluacions of exchange rae on general price level before and afer adopion of inflaion argeing regime in Turkey. Along wih he mos of he counries adoped Inflaion Targeing (IT) regime, relaed lieraure inensively focuses on he impac of inflaion argeing regime on exchange rae pass hrough. Accordingly, his sudy also focuses on how changes in he exchange rae are ransmied o he consumer prices in Turkey afer adoping IT regime explicily in In his framework, we examine exchange rae pass hrough in Turkey applying Vecor Error Correcion (VEC) model for he monhly daa over he pre-it period from 1995 o 2000 and he pos-it period from 2006 o The findings indicae ha he exchange rae pass-hrough decreases in he pos-it period compared o pre- IT period. Thus, as indicaed previous lieraure on exchange rae pass-hrough under inflaion argeing regime in Turkey (Volkan e. al 2007; Kara and Öğünç 2008; Dedeoğlu and Kaya 2014; Arslaner e. al 2014), our sudy also presens evidence of a similar decline in he pass-hrough ha adoped an inflaion argeing scheme. However, alhough previous sudies used mosly he mehods based on single equaion models and vecor auoregressive (VAR) models, we use an 46

11 alernaive esimaion mehod, namely vecor error correcion (VEC) model. Therefore, his sudy conribues o he exising evidence on he developmen of exchange rae pass-hrough under inflaion argeing regime by using alernaive esimaion mehod. Empirical resuls clearly indicae ha he decline in he pass-hrough in Turkey is he resul of he low inflaion environmen experienced afer adopion of inflaion argeing regime. In his way, empirical resuls also show ha developmen of exchange rae passes hrough process in Turkey idenifies he effeciveness of inflaion argeing policy. Thus, i can also be argued ha moneary and correspondingly exchange rae regimes are among he major deerminans of he exchange rae pass hrough process. This finding has imporan implicaions for policy-makers ha he adopion of a credible regime of low inflaion under inflaion argeing regime has been insrumenal in driving he exchange rae pass-hrough down. Accordingly, if he cenral bank aims o decrease exchange rae pass-hrough hen esablishing a credible low inflaion environmen under inflaion argeing regime is essenial. Acknowledgemens Earlier version of his paper was presened in he European Financial Sysem Conference held in Brno, Czech Republic on June 18-19, References Aliyu, S. U. R., Yakub, M.U., Sanni, G. K. and Duke, O.O. (2009). Exchange Rae Passhrough in Nigeria: Evidence from a Vecor Error Correcion Model. MPRA Paper, No: Ahn, J. and Park, C. (2014). Exchange Rae Pass hrough Producer Prices: Evidence from Korean Firm Level Pricing Survey. Economics Leers, 125(1), pp Arslaner, F., Karaman, D., Arslaner, N. and Kal, H. S. (2014). The Relaionship beween Inflaion Targeing and Exchange Rae Pass-Through in Turkey wih a Model Averaging Approach. Cenral Bank of he Republic of Turkey Working Paper No. 14/6. Barhoumi, K. (2006). Differences in he long run exchange rae pass-hrough ino impor prices in developing counries: An empirical invesigaion. Economic Modeling, 23, pp Beirne, J. and Bijserbosch, M. (2011). Exchange rae pass-hrough in cenral and easern EU Member Saes. Journal of Policy Modeling, 33, pp Campa, J. M. and Goldberg, L. S. (2002). Exchange rae pass-hrough ino impor prices: a macro or micro phenomenon. NBER Working Paper Series, No Carranza, L., Galdon-Sanche,z J. E. and Gomez-Biscarri, J. (2009). Exchange Rae and Inflaion Dynamics in Dollarized Economics. Journal of Developmen Economics, 89, pp Choudhri, E. U. and Hakura, D. S. (2001). Exchange Rae Pass-Through o Domesic Prices: Does he Inflaionary Environmen Maer? IMF Working Paper, WP/01/194. Civcir, I. and Akçağlayan, A. (2010). Inflaion Targeing and he Exchange Rae: Does i Maer in Turkey. Journal of Policy Modeling, 32, pp

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