Abstract:

Monetary policy loses its function when the public debt of an economy is high and short-term and a large amount of this debt is foreign currency denominated. In such a case, an increase in short-term interest rates applied as a tool of tight monetary policy to reduce inflation leads to higher risk premiums and generates capital outflow. Thus, such a policy increases the inflation, causing an unexpected result. In this regard, fiscal dominance can be claimed to play a decisive role in the effective operation of monetary policy. In Turkey, fiscal dominance reached very high levels especially in the aftermath of the crisis of February 2001. This study analyzes monetary policies adopted in Turkey between 2002 and 2012 according to specific periods. Within this framework, we firstly investigate the period when implicit inflation targeting regime was implemented and financial dominance was high. Secondly, we examine the period when explicit inflation targeting regime was adopted, followed by the period when monetary policy took price stability along with fiscal stability into consideration. With this classification, we aimed to analyze the impact of fiscal dominance on the implementation of the monetary policy in Turkey in the period analyzed.

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