The Reflection of European Central Bank

THE REFLECTION OF EUROPEAN CENTRAL BANK MONETARY POLICY APPLICATIONS
ON CENTRAL BANK OF THE REPUBLIC OF TURKEY
Res.Asst.Nihat ALTUNTEPE
Suleyman Demirel University/Faculty of Economic and Administrative Sciences Department of Economics
Postal Address: Suleyman Demirel University Faculty of Economic and Administrative Sciences
Department of Economics Çünür/ISPARTA
E-mail: nihata@iibf.sdu.edu.tr
Lect. Selen IŞIK MADEN
Suleyman Demirel University Gonen Vocational School
Postal Address: Suleyman Demirel University Gonen Vocational School
Gonen/ISPARTA
E-mail: smaden@sdu.edu.tr
─Abstract ─
One of the instruments which is used to perform economic policy is monetary policy. The changes which has
appeared in the monetary policy can affect macroeconomic variables positively or negatively. Monetary
policies which have been carried out in the national economies also have been influenced by developments
in the world economy. The institutions in the economies which carry out monetary policies are Central
Banks. So, functions of central banks are very important.
The aim of this study is to display the reflections of European Central Bank’s monetary policy applications
on the Central Bank of the Republic of Turkey’s monetary policy applications in Turkey which has been
improving under the process of European Union membership. In this study, the monetary policies of the two

central banks will be studied.

Key Words:

Monetary Policy, Central Bank, Monetary Union

JEL Classification: E42

1. INTRODUCTION
The European Central Bank is the embodiment of modern central banking: the overriding objective of its
monetary policy is price stability; it is independent within a clear and precise mandate; and it is fully
accountable to the citizens and their elected representatives for the execution of this mandate. Established by
the European Community Treaty, the European Central Bank is embedded in the specific legal and
institutional framework of the European Community. In 2001 Central Bank of the Republic of Turkey also
expounded it is aim as: “The primary objective of the Bank shall be to achieve and maintain price stability.
The Bank shall determine on its own discretion the monetary policy that it shall implement and the monetary
policy instruments that it is going to use in order to achieve and maintain price stability”. In this paper, the
monetary policies of the two central banks will be studied and the policy instruments will be examined.

2. DEFINITION AND OBJECTIVES OF MONETARY POLICY

2.1. Definition of Monetary Policy
Monetary policy is the process by which governments and central banks manipulate the quantity of money in
the economy to achieve certain macroeconomic and political objectives. The targets are usually: economic
growth, changes in the rate of inflation, higher level of employment, and adjustment of the exchange rate.
Monetary policy can be categorized into two types: contractionary and expansionary. Contractionary (tight)
monetary policy aims to reduce the amount of money circulating through the economy, and reduce shortterm economic growth in exchange for higher long-term growth. Expansionary (loose) policy, on the other
hand, aims to increase the money supply and increase short-term economic activity at the expense of longterm economic activity.
Central bankers control interest rates in an effort to stabilize output and inflation. Changes in interest rates
affect most of us directly through increases or decreases in the cost of borrowing, while stable prices and
steady real growth make our economic and financial planning much easier. In most countries today, the
central bankers are the only governmental authorities engaged in stabilization policy. Economists and policy
makers now agree that fiscal policy, once thought to be capable of helping to smooth fluctuations in real
growth, is not up to the task. Central banks are the sole remaining policy making bodies thought capable of
reducing business-cycle fluctuations. (Cecchetti,2000: 43-44)
2.2. Objectives of Monetary Policy
In this section, various reasons why central banks stabilize prices and output will be discussed. It will be
also discussed at some length why it is that they smooth interest rates, and how this is a consequence of their
actions, not an objective in and of itself.
2.2.1. Stabilizing Prices
The most common response dissatisfaction with inflation is that inflation is responsible for declines in real

income. There are many reasons that we can identify why high inflation is inherently unstable.
One cost of inflation is the tax on the money that is holded. More specifically, it is a tax on the monetary
base. A second cost of inflation relates to taxes. The tax system in most countries is not properly indexed,
and so there are welfare losses associated with inflation. The papers in Feldstein (Felstein,1996: 9) show that
these effects can be quite substantial, and so it may be worth paying a fairly high price to reduce inflation to
near zero .Beyond tax distortions, inflation creates disturbance in the price system. When there is aggregate
price inflation, it becomes more difficult to discern changes in relative prices. Fourth cost of inflation is that
at high levels of inflation, people tend to invest substantial time and effort into finding ways to reduce its
costs. Finally, there is the empirical fact that high inflation is uncertain inflation. Overall, central bankers
now agree that the costs of inflation are high, and that variable inflation entails significant social losses. As a
result, the primary objective of monetary policy, and the one that appears to be within the grasp of the policy
makers, is to stabilize inflation about a level that is low enough that it becomes irrelevant for household and
firm decision making. (Cecchetti,2000: 47)

2.2.2. Stabilizing Output
Economists have long recognized that some sources of economic fluctuations imply that output stability and
inflation stability are mutually reinforcing. For example, if there is a negative shock to aggregate demand
households will cut spending. The drop in demand leads, in turn, to a decline in actual output relative to its
potential. As a result of increased slack in the economy, future inflation will fall below levels consistent with
price stability. The central bank will pursue an expansionary policy to keep inflation from falling. This

expansionary policy will result in an increase in demand that boosts output toward its potential to return
inflation to a level consistent with price stability. Stabilizing output stabilizes inflation under these
conditions. (Mishkin, 2008: 3-4)

2.2.3. Stabilizing Interest Rates
Central banks tend to change their policy instrument in time. There are too many continuations of policy
changes, relative to what would be predicted by any sort of sensible model of monetary policy actions.
Interest rate smoothing is one of these continuation policy instruments.

There are several possible explanations about where does this interest rate smoothing come from. One is that
the central bank takes it as an explicit objective to keep interest rates smooth in order to insure financial
stability. Another explanation is that smooth interest rates enhance credibility. The objective of monetary
policy should be the stabilization of the domestic economy through the reduction in the variability of prices
and output growth. Optimal monetary policy may entail interest rate smoothing, but there is no justification
for this to be an explicit objective. (Cecchetti,2000: 50)
3. EUROPEAN CENTRAL BANK – OBJECTIVES AND INSTRUMENTS OF MONETARY
POLICY
The creation of Economic and Monetary Union (EMU), with a supranational monetary authority and a
common currency is a key point of the Maastricht Reforms, which came to the forefront of attention to the
European Union and with preparations for joining EMU. Responsibility for monetary policy in the

framework of the European Union lies with two institutions (Article 8 of the Maastricht Treaty), the
European System of Central Banks (ESCB) and the European Central Bank (ECB). The legislative
framework for their activity is contained in Title VI of the Treaty – Economic and Monetary Policy and in
the Protocol on the Statute of the ESCB and ECB. (EC,1999:20) The European System of Central Banks
(Article 107 of the Treaty) has, from the formal aspect, two levels, the European Central Bank and the 15
national central banks of the member states of the European Union. The European Central Bank, together
with the 12 national central banks of the eurozone, constitutes the eurosystem. The ESCB is governed by
decision-making bodies of the European Central Bank.
The European Central Bank is responsible for an area that comprises 12 countries. For achieving the aims of
the ECB, it is important to transparently and comprehensively inform the public of steps taken by the ECB
and the tasks it sets itself. The Maastricht Treaty creates a mechanism for ensuring that monetary union,
together with the single currency, forms a stable alignment. The institutional predecessor of the ECB was the
European Monetary Institute, which operated from 1 January 1994. Through the establishment of EMU on 1
January 1999 responsibility for monetary policy passed from the national central banks of member states to
the ECB. The ECB shall have a legal personality. Its first President was the Dutchman Willem F. Duisenberg
and on 1 November 2003 the office passed to the Frenchman Jean-Claude Trichet. The ECB is situated in
Frankfurt am Main in Germany. (Tancosova,2004: 2)
3.1. The Organisation of The European Central Bank
In Article 105 of the Treaty on the European Union it is stated that the primary objective of the ESCB is to
maintain price stability. Without prejudice to this objective the ESCB shall support “general economic

policies in the Community with the objective of contributing to achieving the Community’s aims”, which are
defined in Article 2 of the Treaty. Through such a normative delimitation of the objective, the stability of the
euro's purchasing power has been made an absolute priority. The Governing Council of the ECB has
quantitatively defined price stability as “a year-on-year increase in the harmonised index of consumer prices
(HICP) in the eurozone of less than 2%.” (ECB,2004:9-10)
On the basis of Article 106 of the Treaty the European Central Bank has the exclusive right to authorise the
issue of banknotes in the Community. Banknotes issued by the ECB and national central banks are the sole
banknotes in the Community having the exclusive status of legal tender. Member states may issue only coins
in a certain volume approved by the ECB. (Official Journal of the European Communities,2002:8)
The supreme decision making body of ECB is the Governing Council. The Governing Council formulates
the Community's monetary policy, including monetary aims, key interest rates, and monetary reserves of the
ESCB, adopts the rules of procedure, and performs advisory functions. Responsibility for the day-to-day
running of the ECB, the preparation for meetings of the Governing Council and for the implementation of
monetary policy lies with the Executive Board of the ECB, which gives instructions in this field to the
national central banks. The General Council of the ECB has the role of co-ordinating monetary policy and
co-operating in the field of exchange rate policy. While there remain countries outside the eurozone, the
General Council of the ECB will also be involved in the preparation of their entry to EMU. (ECB, 2004:1112)

3.2. Monetary Policy of the ECB
In October 1998, the ECB presented its strategy. It is based on price stability. The objective of price stability

refers to the general level of prices in the economy and implies avoiding both prolonged inflation and
deflation. ( Hagen and Brückner, 2001: 7) Inflation leads to uncertainty about relative prices and the future
price level, making it harder for firms and individuals to make appropriate decisions, thereby decreasing
economic efficiency (Lucas, 1972: 112; Briault, 1995: 34).
There are several ways in which price stability contributes to achieving high levels of economic activity and
employment. First, price stability makes it easier for people to recognize changes in relative prices. As a
result, firms and consumers do not misinterpret general price level changes as being relative price changes
and can make better informed consumption and investment decisions. Second, if creditors can be sure that
prices will remain stable in the future, they will not demand an inflation risk premium to compensate them
for the risks associated with holding nominal assets over the longer term. Third, the credible maintenance of
price stability also makes it less likely that individuals and firms will divert resources from productive uses
in order to hedge against inflation. Fourth, tax and welfare systems can create perverse incentives which
distort economic behavior. Fifth, inflation acts as a tax on holdings of cash. This reduces household demand
for cash and consequently generates higher transaction costs. Sixth, maintaining price stability prevents the
considerable and arbitrary redistribution of wealth and income that arises in inflationary as well as
deflationary environments, where price trends change in unpredictable ways. (ECB,2004:11-12)
All these arguments suggest that a central bank that maintains price stability makes a substantial contribution
to the achievement of broader economic goals, such as higher standards of living, high levels of economic
activity and better employment prospects.
3.3. General Principles of the ECB’s Monetary Policy Strategy

There are various monetary policy strategies which have been pursued by central banks. One such strategy is
monetary targeting, another strategy is direct inflation targeting and the third strategy is exchange rate
targeting.
While central bank experiences with the design of the ECB’s strategy, the ECB decided not to adopt
monetary targeting. This decision acknowledged the existence of information in macroeconomic variables
other than money that is important for monetary policy decisions aimed at price stability. (ECB,2008: 33)
Direct inflation targeting focuses on developments in inflation itself relative to a published inflation target.
The central bank’s forecast for inflation is therefore placed at the centre of policy analysis and discussions,
both within the central bank and in its presentations to the public. Focusing entirely on a forecast inflation
figure does not provide an encompassing and reliable framework for identifying the nature of threats to price
stability. The ECB considers that relying on a single forecast would be unwise. (CBRT,2004:17-18)
Thirdly, exchange rate targeting, which was pursued by several European countries prior to Monetary Union
in the context of the exchange rate mechanism of the European Monetary System. An exchange rate
targeting strategy was not considered appropriate for the euro area, as it is a large and relatively closed
economy where the impact of exchange rate developments on the price level is more modest. (ECB,2008:
33)
The challenge faced by the ECB while carrying out the monetary policy can be stated as follows: the
Governing Council of the ECB has to influence conditions in the money market, and thereby the level of
short-term interest rates, to ensure that price stability is maintained over the medium term. In so doing, the
central bank is continuously confronted with a high level of uncertainty regarding both the nature of the

economic shocks hitting the economy and the existence and strength of the relationships that link
macroeconomic variables.
The first element of the ECB’s monetary policy strategy is a quantitative definition of price stability. In
addition, the strategy provides a framework which ensures that the Governing Council assesses all the
relevant information and analysis needed to take monetary policy decisions in a forward-looking manner and
thereby ensure the maintenance of price stability. In this respect, the strategy also provides a framework for
explaining monetary policy decisions to the public in a clear and transparent manner. (ECB,2008: 34)

3.3.1. The ECB’s Quantitative Definition of Price Stability
The Governing Council of the ECB announced the following quantitative definition in 1998: “Price stability
shall be defined as a year-on-year increase in the Harmonised Index of Consumer Prices (HICP) for the euro
area of below 2%. Price stability is to be maintained over the medium term”. The Governing Council
decided to publicly announce a quantitative definition of price stability for a number of reasons. First, by
clarifying how the Governing Council interprets the goal it has been assigned by the Treaty, the definition
helps to make the monetary policy framework easier to understand. Second, the definition of price stability
provides a clear and measurable yardstick against which the public can hold the ECB accountable. Finally,
the definition provides guidance to the public for forming expectations of future price developments. All
these positive features of the definition were even further enhanced by the clarification of the Governing
Council that it aims, within the definition, at inflation rates of close to 2%. (ECB,2008:35)
3.3.2. The Two Pillars of the ECB’s Monetary Policy Strategy

The ECB’s approach to organising, evaluating and cross-checking the information relevant for assessing the
risks to price stability is based on two analytical perspectives, referred to as the two pillars. This approach
was confirmed and further clarified by the Governing Council of the ECB in May 2003. (ECB,2008:36) The
two-pillar approach is designed to ensure that no relevant information is lost in the assessment of the risks to
price stability and that appropriate attention is paid to different perspectives and the cross-checking of
information in order to come to an overall judgement on the risks to price stability.
Table 1: The Two Pillars of the ECB’s Monetary Policy Strategy
Primary Objective of Price Stability

Economic
Analysis

Governing Council takes monetary policy
decisions based on its overall assessment of
the risk to price stability

Analysis of economic
shocks and dynamics

Cross

checking

Monetary
Analysis

Analysis of monetary
trends

Full set of information
Source: ECB:2008:39

3.3.2.1. Economic Analysis
The economic analysis focuses on the assessment of current economic and financial developments and the
implied short to medium-term risks to price stability. It analyses all factors which are helpful in assessing the
dynamics of real activity and the likely development of prices in terms of the interplay between supply and
demand in the goods, services and labour markets. The economic analysis also pays due attention to the need
to identify the nature of shocks hitting the economy, their effects on cost and pricing behavior and the short
to medium-term prospects for their propagation. The ECB regularly reviews developments in overall output,
demand and labour market conditions, a broad range of price and cost indicators, fiscal policy, and the
balance of payments for the euro area. Developments in financial market indicators and asset prices are also
closely monitored. Movements in asset prices may affect price developments via income and wealth effects.
The Eurosystem’s staff macroeconomic projections, which are prepared twice a year by the staff of the ECB

and the National Central Banks(NCB)s, play an important role in the economic analysis. The Governing
Council evaluates them together with many other pieces of information and forms of analysis organised
within the two-pillar framework; but it does not assume responsibility for the projections. The published
projections are the result of a scenario based on a set of technical assumptions, including the assumption of
unchanged short term interest rates. In view of this, the projections represent a scenario that is unlikely to
materialise since monetary policy will always act to address any threats to price stability. (ECB,2004:61-62)
3.3.2.2. Monetary Analisis
The ECB’s monetary analysis relies on the fact that monetary growth and inflation are closely related in the
medium to long run. Assigning money a prominent role therefore underpins the medium-term orientation of
the ECB’s monetary policy strategy. Indeed, by taking policy decisions not only on the basis of the short to
medium-term indications stemming from the economic analysis, but also on the basis of money and liquidity
considerations, the ECB is able to see beyond the transient impact of the various shocks and avoids any
temptation to take an overly activist course.
To signal its commitment to monetary analysis and provide a benchmark for the assessment of monetary
developments, the ECB has announced a reference value for the growth of the broad monetary aggregate
M3. This reference value refers to the rate of M3 growth that is deemed to be compatible with price stability
over the medium term. In December 1998 the Governing Council set this reference value at 4½% per annum
and confirmed it in subsequent reviews. The reference value is based on the definition of price stability and
on the medium term assumptions of potential real GDP growth of 2-2½% and a decline in the velocity of
circulation of money of between ½% and 1%.
The ECB’s monetary analysis is not limited to the assessment of M3 growth in relation to its reference value.
Many other monetary and financial variables are closely analysed on a regular basis. In this respect,
narrower aggregates such as M1 may contain some information about real activity. Similarly, changes in
credit extended to the private sector can be informative about financial conditions and, through the monetary
financial institutions (MFI) balance sheet, can provide additional information about money. Such analysis
helps to provide both a better insight into the behaviour of M3 in relation to the reference value and a broad
picture of the liquidity conditions in the economy and their consequences in terms of risks to price stability.
(Scheller,2006:85)
Table2: Average M3,Inflation Rate and Interest Rates in Euroarea
199
9

200
0

200
1

200
2

200
3

200
4

200
5

200
5

200
7

2008

M3

5,6

4,8

5,5

7,2

8,08

5,7

7,4

8,5

11,1

10,7*

Inflatio
n

1,1

2,1

2,3

2,2

2,1

2,1

2,2

2,2

2,1

3,3**

3

4,7

3,2

2,7

2

2

2,2

2,2

4

3,25***

Rate
Interest
Rates
*first 5 month **first 6 months ***first 7 months
Source: 1998-2000 Monthly Bulletin 10th Anniversary of the ECB p.149

The aim of ECB’s monetary policy strategy is to maintain price stability. As seen in Table 2 Euroarea has
also been affected by global economic developments. Especially M3 and interest rates rose. From 1999 to
2007, the inflation rate has remained substantially near to the 2% target, remaining most of the time below
2.5%.
The prominent role assigned to money in the ECB’s monetary policy strategy was motivated by thr notion
that the development of the price level in the medium to longer term is a monetary phenomenon.
(ECB,1999:29) This view was supported by a number of empirical studies showing that the long-run euro
area M3 demand function was stable. (Brand and Casola,2000:24, Coenen and Vega,1999:27 , Calza et al.,
2001:18) and that M3 based indicators were leading euro area inflation at medium term horizons.

(Altimari,2001:28) In fact, since 2001 euro area M3 has been growing at rates well above its reference value
of 4,5%, while HICP inflation has remained broadly stable at rates around 2%. This observation seems to
confirm the view that M3 growth has not been a reliable indicator for future price developments in the euro
area recently. (Hofmann,2008:7)
4. Central Bank of the Republic of Turkey and Monetary Policy Strategies After 1999
In this part of the study, monetary policies of Central Bank of Republic of Turkey after 1999 will be
examined. As we are trying to see the reflections of ECB’ a monetary policy strategy on the Central Bank of
Republic of Turkey, year 1999 (establishment of ECB) is chosen as beginning.
4.1. Central Bank of the Republic of Turkey and Duties
The Bank was established on October 3, 1931 and opened officially on January 1, 1932. The Bank had,
originally, a privilege of issuing banknotes for a period of 30 years. In 1955 this privilege was extended until
1999. Finally it was prolonged indefinitely in 1994.
According to the Law No: 1715, the basic aim of the Bank was to support economic development of the
Country. In order to fulfill this aim, the Bank was given the following duties (CBRT,2008):


To set rediscount ratios and to regulate money markets,



To execute Treasury operations,



To take, jointly with the Government, all measures to protect the value of Turkish currency.

With the introduction of economic development plans in Turkey in the Sixties, several changes were made in
the Central Bank Law.
In the second half of the Eighties, the Bank inaugurated interbank money market, foreign exchange money
market and started to make use of open market operations.
In 2001, Central Bank Law No:1715 article 4, amended. According to amendend article 4: The primary
objective of the Bank shall be to achieve and maintain price stability. The Bank shall determine on its own
discretion the monetary policy that it shall implement and the monetary policy instruments that it is going to
use in order to achieve and maintain price stability. The Bank shall, provided that it shall not be in
confliction with the objective of achieving and maintaining price stability, support the growth and
employment policies of the Government. (CBRT, 2008)
The fundamental duties and powers of the Bank shall be to carry out open market operations, to conduct
rediscount and advance transactions, to manage the gold and foreign exchange reserves of the country, to
regulate the volume and circulation of Turkish Lira, to establish payment, to monitor the financial markets,
etc. Fundamental powers of the Bank are, privilege of issuing banknotes, determine the inflation target
together with the Government and adopt the monetary policy, utilize monetary policy instruments, carry out
the operations of extending credits to banks, etc (CBRT, 2008)
4.2. General Principles of Central Bank of the Republic of Turkey’s Monetary Policy Strategy
In this section the monetary policies of Central Bank of the Republic of Turkey will be examined in three
periods of 1999-2002, 2002-2005 and after 2005. In these 3 periods the monetary policy strategies differ
from eachother.
4.2.1. Period of 1999-2002
Exchange Rate-Based Disinflation Program introduced in December 1999 was the key element that shaped
the framework of monetary policy and economic developments in 2000. The program aimed at increasing
primary surplus via tight fiscal policy, realizing structural reforms, accelerating privatization and
implementing an incomes policy consistent with the inflation target. However, the basic policy instruments
of the program have been the exchange rate and monetary policy. In order to sustain the exchange rate
regime, the Central Bank set net domestic assets, and the growth of balance sheet was determined by the
increase in net foreign assets. This quasi currency board policy framework ruled out the possibility of
sterilization, the liquidity expansion was linked to reserve build-up and restricted the flexibility of the
Central Bank on short-term interest rates. (CBRT,2001:1)

Monetary and exchange rate policies for 2001 were announced at the end of 2000. Accordingly, the
exchange rate policy would be carried out within the same framework.. While the main principles of
monetary policy for 2000 were maintained, new targets were set for Net Domestic Assets and Net
International Reserves. The unfavorable developments of November and February have compelled the
Central Bank to follow policies that have been formulated to re-establish stability in financial markets after
the crisis. All with this, “Transition to Strong Economy Program" was announced together with its measures
and legal regulations. The program has emphasized on structural reforms and legal regulations rather than
conjunctural policies. Abandonment of the existing exchange rate regime necessitated changing of the
monetary policy strategy. For this purpose, a more active monetary policy has been designed and new
performance criterion have been mentioned. Since the exchange rate anchor was abandoned, Base Money
has been determined both as an intermediate target and a nominal anchor to provide a criterion to the
economic agents to form their inflationary expectations. (CBRT,2001:8)
The Central Bank had formerly announced that inflation targeting regime would be implemented starting
from the beginning of 2002. However, the conduct of inflation targeting was postponed because of the
disturbances in money and foreign exchange markets arising from terrorist attacks of September 11,
uncertainty atmosphere created by external financing needs, and high inflation level and rigid inflationary
expectations. During this period, which will be a transition stage to inflation targeting system, the Central
Bank will formulate the monetary policy towards reestablishing the price stability in the economy. In this
framework, base money aggregate consistent with growth and inflation targets has been fixed as a
performance criterion as of 2001. Similar to 2001, the aggregates related to net domestic assets and net
international reserves will closely be monitored and short-term interest rates will effectively be used towards
the inflation target. Moreover, priority will be given to enlightening of public and transparency issues.
Announcements will regularly be made on the implementation of the monetary policy. With the signs of
favorable progress in preconditions, transition to the inflation targeting system will come into effect.
(CBRT,2001:9)
4.2.2. Period of 2002-2005
The monetary policy, which was launched at the beginning of year 2002, with Base Money as the nominal
anchor and the interests as monetary policy instruments under floating exchange regime, has been pursued in
this period too. In the said period, the CBRT has carried on with its implementations intended for attaining
its final goal of price stability and enhancing financial stability in accordance with this goal. (CBRT:2002: 3)
Implicit inflation targeting and Base Money were the basic nominal anchors of the monetary policy in 2002.
The short-term interest rates, which are the main policy instruments of the Central Bank for stability
objective, have been set after a comprehensive assessment of the effects of various macroeconomic variables
on the future inflation developments. (CBRT,2003:1)
Implicit inflation targeting policy, which has been put into practice in 2002, is maintained in 2003. In
accordance with this policy while short term interest rates are employed as the primary policy tool, monetary
performance criteria and indicative targets are monitored within the framework of the program carried out
with IMF. All criteria and targets set for the end of Arpil, June and September 2003 were achieved.
Nevertheless, developments in October and November brought forth the possibility of exceeding the upper
limit of end-year money base target. (CBRT,2003:23)
Achieving the inflation targets in both 2002 and 2003 demonstrates the success of the economic program and
disinflation efforts. In the first quarter of 2004, favorable cost conditions persisted, the level of domestic
demand did not put pressure on prices by forcing production capacity and the inflation expectations were
consistent with the year-end target. (CBRT,2004 a: 4)
A decision was made on 17 December 2004 for the start of the negotiation process with the European Union
(EU) for full membership. This is believed to have had a favorable impact on the reform process
implemented within the framework of the economic program. The insignificant impact of cost factors on
inflation and the effectiveness of 2005 inflation target on expectations are important developments with
respect to the inflation targeting regime, which was introduced in 2006. 2005 is the year of transition to the
new regime, during which the process and timing of interest rate decisions will be rendered more transparent
and foreseeable, and thus consistent with formal inflation targeting. (CBRT, 2004 b: 1)

Therefore, interest rate decisions are made by taking into account the evaluations of the Monetary Policy
Committee on the economy, the meeting days of which are announced in advance, and the decisions are
publicized in the morning of the following working day. In addition, a further press release is issued with the
title of “Inflation and Outlook” within two days of the meeting, explaining the rationale behind the decision,
as well as CBRT’s general evaluations of the economic outlook. (CBRT, 2005: 20)
Due to the currency reform in 2005 six zeros were removed from the Turkish lira, enabling the borrowing
instruments denominated in the New Turkish lira to be kept under the custody of international clearing
houses. Together with the favorable economic developments, foreign finance institutions with high credit
ratings began to issue bonds denominated in the New Turkish lira. These issues extended maturities and
enhanced financial depth, created a potential to expand credit supply without causing maturity mismatch, as
well as increased the capability of the Treasury for long-term bond issues. (CBRT, 2006 a : 41)
4.2.3. After 2005
The Central Bank of the Republic of Turkey (CBRT) adopted an inflation targeting regime starting in
January 2006. Within the framework of the implicit inflation targeting strategy during 2003-2005, end-year
inflation targets were announced and realizations undershot the targets. The favorable outcome of inflation
rates remaining below the targeted rates in recent years led to perceptions that the targets announced by the
CBRT were the upper limit, which was a reasonable strategy under the disinflation period. However, from
now on, the CBRT will treat any upward or downward deviations from the target symmetrically. In other
words, a significant downward shift of inflation from the target will be treated as seriously as an upward
deviation. As it takes time for monetary policy decisions to influence the economy, monetary policy will
focus on the consistency of the future, as opposed to the current, rate of inflation with the respective targets.
(CBRT, 2006 b :51)
In the first year of the inflation-targeting regime, some supply-side shocks were experienced, which caused
inflation to materialize above the path consistent with the target but important steps were taken in 2006 on
the way to transparency, accountability and predictability, which are the main principles of the inflation
targeting regime. (CBRT, 2006 b: 1)
CBRT has continued implement the monetary policy in 2007 based on the principles of inflation targeting
regime. The Monetary Policy Committee meetings were held in line with the pre-announced annual
timetable. Inflation in the first quarter of 2007, as foreseen, remained within the uncertainty band set around
the path consistent with the target, whereas the decline in inflation stagnated in the last quarter due to both
considerable increases in food prices, arising from drought as well as global conjuncture, and adjustments in
administered prices. Thus, it has become obvious that the year-end inflation would remain outside the
uncertainty band. (CBRT, 2007: 1)
Food, energy and other commodity prices continued to have adverse effects on inflation in the first quarter of
2008. Oil prices continued to rise. Moreover, rising financial volatility and declining risk appetite on the
back of ongoing global uncertainties have led to exchange rate movements which had first round effects on
March inflation. Consequently, inflation rose to 9,15 percent at the end of the first quarter, breaching the
upper limit of the uncertainty band. (CBRT,2008 a: 1) The inflation target for 2008 was 4% but in the end of
June inflation rose to10,61%. (CBRT,2008 b: 1) With these assessments together CBRT propose to revise the
targets for 2009 and 2010 to 7.5 and 6.5 percent, respectively; and to set the target for the year 2011 at 5.5
percent.
Table 3: Inflation Targets and ex-post Values
200
2

200
3

200
4

200
5

200
6

200
7

2008

200
9

201
0

2011

Target

35

20

12

8

5

4

4

4

4

Ex-post

29.7

18.4

9.3

7.7

9.6

8.39

10.61*

-

-

-

Revised
target

-

-

-

-

-

-

-

7.5

6.5

5.5

* Inflation in June
Source: CBRT

In the table above inflation targets and ex-post values are seen during the period of inflation targeting
regime. During the period of implicit inflation targeting ex-post values are below the target value but during
the inflation targeting period ex-post values are higher than the target. Also revised target values are shown
for 2009-2011 period.
5. CONCLUSION
The main objective of the ECB is to maintain price stability has not changed to any significant extent since
its establisment in 1999. Rather than taking direct responsibility for elimination of any output gap, the ECB
purports to provide an environment in which the economy can naturally close the gap and that is done mostly
through maintaining inflation near to 2% annually. The ECB’s strategies for achieving price stability are
based on the two pillars approach: 1) assessing the short to medium-term determinants of price
developments, with a focus on real activity and financial conditions in the economy (economic analysis); 2)
focusing on a longerterm horizon, exploiting the long-run link between money and prices (monetary
analysis). The ECB decided not to adopt strict price targets because, in its view, this is too mechanical and,
like the monetary rule, does not take into consideration other relevant variables. The European central bank
believes that, in the medium long term, monetary policy can be conducted by controlling M3.
Exchange Rate-Based Disinflation Program introduced in 1999 was the key element that shaped the
framework of monetary policy and economic developments in 2000 for The Central Bank of the Republic of
Turkey. . The program aimed at increasing primary surplus via tight fiscal policy, realizing structural
reforms, accelerating privatization and implementing an incomes policy consistent with the inflation target.
However, the basic policy instruments of the program have been the exchange rate and monetary policy.
Under the global developments and with the idea of controling the inflation more effectively to maintain
price stability The Central Bank had formerly announced that inflation targeting regime would be
implemented starting from the beginning of 2002. Implicit inflation targeting and Base Money were the
basic nominal anchors of the monetary policy between 2002 and 2005. The Central Bank of the Republic of
Turkey adopted an inflation targeting regime starting in January 2006. In the first year of the inflationtargeting regime, some supply-side shocks were experienced, which caused inflation to materialize above the
path consistent with the target but important steps were taken in 2006 on the way to transparency,
accountability and predictability, which are the main principles of the inflation targeting regime.
Considering two central banks, the aim of the monetary poicy is same as maintaining pirce stability. But the
monetary poicy strategies are different. The ECB’s monetary policy strategy comprises a quantitative
definition of price stability, and a two-pillar approach to the analysis of the risks to price stability. CBRT’s
monetary policy startegy is inflation targeting to maintain price stability.
Finally, if we asses the indicators for both central banks, for ECB since 2001 euro area M3 has been growing
at rates well above its reference value of 4,5%, while HICP inflation has remained broadly stable at rates
around 2%. This observation seems to confirm the view that M3 growth has not been a reliable indicator for
future price developments in the euro area recently. For CBRT, the inflation target for 2008 was 4% but in
the end of June inflation raised to10, 61%. CBRT propose to revise the targets for 2009 and 2010 to 7.5 and
6.5 percent, respectively; and to set the target for the year 2011 at 5.5 percent. As a matter of fact, the CBRT
has nothing to do with the external supply side shocks; but, since it could not fulfill its commitment, the
credibility of the Bank has deteriorated, and the expectations in Turkey turned into negative, which are the
two worst things for the Governor of a Central Bank.

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