Here is the main question:  how can the CBT implement a monetary policy that targets price stability and financial stability at the same time.

The June 2012 issue of the journal İktisat İşletme ve Finans (Economics, Business and Finance) has a theme that was frequently addressed and discussed at this column for the last two years. Here is the main question it asks:  how can the CBT implement a monetary policy that targets to simultaneously attain price stability and financial stability. I would like to repeat why this critical question is raised: before the global financial crisis, many market economies had concentrated monetary policy efforts on price stability. It was thought that, price stability with a disciplined fiscal policy would automatically ensure financial stability. And a climate of macroeconomic stability was the key prerequisite for sustainable economic growth. Particularly during the late 1990s, inflation rates across developed countries were harmonious with price stability efforts and developing countries were close to achieving price stability having ensured substantial drops in inflation. Yet, the global crisis hit albeit price stability.

This development put into question the monetary policy framework implemented before the global crisis. This is the chief reason why everyone has been endeavoring to answer the question above. In this line, June 2012 issue of İktisat İşletme ve Finans involves studies that investigate the new monetary policy framework of the Central Bank of Turkey (CBT) in the light of possible answers to this question. This special issue of the journal has five articles which is accessible to everyone for a limited period.

The first study is by Hakan Kara, CBT Chief Economist and former Director General for Research and Monetary Policy. It is titled “Monetary Policy in the Post-crisis Period.” The study first discusses the motivation for the new monetary policy framework. Liquidity abundance and historically low interest rates resulting from developed countries’ monetary policy preferences in the post-crisis period pushed up short-term capital inflows towards Turkey and peer developing countries, Kara stresses. Therefore he says, many emerging market economies faced an upwards pressure on domestic currency and suffered from rapid credit expansion. He emphasizes that faced with the risk of financial instability and in line with the change of the prospects for central banking in Turkey and throughout the world, the CBT initiated a new monetary policy framework. Later, he investigates the monetary transfer mechanism and evaluates the new monetary policy with this perspective.

The second study is by Hasan Ersel. It is titled, “What kind of a mechanism can be designed for attaining financial stability?” The study starts by emphasizing that instability is the price to be paid for financial system’s dynamism. With reference to this observation, Ersel stresses that the main question is how to preserve the dynamism and how to prevent the instability caused by this dynamism to affect negatively the real sector and the financial sector per se. In this context, he maintains that the traditional macro-micro distinction of the pre-crisis period – in other words, the classical division of labor between central banks and regulatory and supervisory authorities, where the former is responsible for price stability and the latter for financial stability – falls short of preventing financial stability. He argues that as important as it is; the soundness of financial institutions is not enough to attain financial stability. With this perspective, he discusses what kind of a mechanism can be designed for attaining financial stability.

I recommend this special issue of the journal for a valuable debate furnished with different opinions. I will introduce the other three studies on Thursday.

This commentary was published in Radikal daily on 05.06.2012