The last two commentaries of 2009 were an introduction to what measures can be taken against the appreciation of Turkish lira. The first commentary asked what we would do if Turkey manages to create a new success story and thus the Turkish Lira tends to appreciate. I firstly recalled post- 2001 period and mentioned the positive impacts of the appreciation (low exchange rate) enjoyed back then.  Then, I underlined that low exchange rate that will come up if a new story is created will least possibly ensure positive effects as was enjoyed in the post-2001 period. The second commentary finished like this: "In that case, if we get a new 'economic story' that will lead to low exchange rate in the coming period, exports will be affected quite adversely unlike the case in the post-2001 crisis period. So, the question to ask is what to do then."

Let me first talk about monetary policy. Central Bank can follow two alternatives. First is sticking within the framework of the current inflation targeting, and cutting down interest rates as the exchange rate falls considering its positive impact on inflation. The Bank has already declared that this option will be followed (Monetary Policy Board Meeting Minutes published on December 29, Article 19). It is now easier than in the post-2001 period to respond to low exchange rate with reducing interest rates. Back then, some developments which could raise concerns about the sustainability of the stability program could occur; but these were not necessarily disclosed to the public. In that case, though exchange rate remained at low levels, Central Bank did not necessarily cut down interest rates sufficiently since as disputes were prolonged or became known to everyone exchange rate could have jumped or upwards pressure on inflation could have been created. Now, we are not faced with such a risk.

The second alternative the Central Bank can follow is changing the framework of current inflation targeting regime: Currently, Central Bank responds to the changes in exchange rate in the context of its impact on inflation; this is an indirect response. The Bank gave indirect response to the changes in exchange rate both under implicit and open inflation targeting regimes. So, as an alternative, Central Bank can directly respond to exchange rate. I occasionally dealt with this subject before the emergence of global crisis; there exist some inflation targeting methods set on the basis of direct response. The benefit of this framework is that it allows larger cuts in interest rate in the event of appreciation of the domestic currency. Of course it also has drawbacks; this way you give mixed signals to the markets: It might become harder to explain the rationale of the interest rate cut, for instance. However, considering the fall in inflation, this is a risk that can be taken.

Of course there is a more radical economic policy alternative: Introducing practices that obstruct short term capital inflows to Turkey; i.e. imposing legal limits on short term capital inflows. Foreign capital of this type particularly is the one we do not much desire. This type of inflows has significant negative impacts on the exchange rate and does not have a considerable benefit for the economy. Before the 2001 crisis, Turkey had a highly distorted macroeconomic policy. Back then, introducing capital regulations without eliminating these distortions would mean sweeping the dust under the carpet. However, this is not the case anymore. Though we have faltered in the way toward stability between 2007 and 2009, we do not have much dust to sweep. What is more, the world has changed and such practices are favored more. Brazil has recently introduced - 'dared' we would say in the past - a similar limitation. We should also consider similar alternatives.

This commentary was published in Radikal daily on 04.01.2010