I hope the extensive use of the policy tool (the material) does not cause a fatigue.

So, how everything started? Before the global crisis, many countries already had achieved price stability and the rest were close to achieving it having ensured substantial drops in inflation. Then came the global financial crisis, albeit price stability. The world learned an obvious lesson: focusing solely on the price stability does not solve all problems.

In periods of rapid economic growth, the risk appetite of the financial sector as well as the corporate sector and consumers increases. This causes the credit supply to grow, for instance, and increases consumption and investments further. Then, growth picks up above the normal. In times of slow growth or economic contraction, on the other hand, risk appetite halts, pushing growth down further below the normal.

Risk appetite

The parallel cycles of risk appetite thus deepen business cycles in market economies. Therefore, following the global crisis, it became better understood that the key to ensuring macro financial stability was to sort risk appetite that moves in parallel with business cycles. The need for measures that will mark down risk appetite in periods of growth and boost it in downturns became clearer.

That was how everything started. The Central Bank of Turkey (CBT) declared that it has two different objectives: price stability and financial stability. The CBT announced that it would not rely solely on the short term interest rate to fulfill the objectives and that it would also employ macro-prudential tools. In this context, the Bank changed required reserve ratios successively between November 2010 and June 2011. You have read on this column many times why changing required reserve ratios could not fulfill the stated objectives and why efforts started to pay off only after the Banking Regulation and Supervision Agency stepped in.

So, where are we now? We are back to somewhere around basics. The CBT recently did not use any tool other than the interest rate, did it? In the past, interest rates were generally kept constant for months or were chanced once a month at most. Lately, however, the CBT has been changing the short term interest rate on a daily basis. We do not know what the level of the short term interest rate would be at a given day; we just know the upper and lower limits of the interest rate corridor.

Back to interest rate policy

In other words, we are back to interest rate policy now. And what a turnaround: Now interest rates are changed on a daily basis. Is this a flexible policy? It certainly is. Is flexibility good? It depends on the objective. For instance, some degree of flexibility is desired for a suspension bridge. If hit by a fresh breeze or a march, however, the flexibility can put the bridge into resonance and crush it down. If the wave length is not taken into account, the flexibility considered as useful can become harmful.

Of course I have an opinion on whether the CBT’s being flexible is a good thing or not. But the purpose of this commentary is not to discuss the advantages and disadvantages of flexibility. I just want to note one thing down: The CBT hit the road to implement a multi-objective monetary policy but ended up using a single policy tool. And it is using this tool each and every day. I polished the commentary with fancy words like resonance. So, let me finish in the same style: I hope the extensive use of the policy tool (the material) does not cause a fatigue. Let’s hope for the best...

This commentary was published in Radikal daily on 24.05.2012