Turkey’s trilemma trade-offs: is there a role for reserves?

Cortuk, Orcan and Singh, Nirvikar (2011): Turkey’s trilemma trade-offs: is there a role for reserves?

Abstract

In this paper, we study the trilemma configuration of the Turkish economy. The paper starts by empirically testing the Mundell-Fleming theoretical concept of an “impossible trinity” (trilemma) for Turkey, following the Aizenman, Chinn and Ito (ACI) approach. This includes calculating the trilemma indices and investigating their evolution over the period of 1998Q1-2010Q4, which is split into three sub-samples according to the Turkey’s macroeconomic policies. We also introduce alternative empirical techniques in order to deal with possible misspecification problems detected in the ACI approach. These techniques include employing additional terms in the regression, Two Stage Least Squares, General Method of Moments and Kalman filtering. The analysis supports the conclusion that the trilemma trade-offs are binding for Turkey for each sub-period. Besides, it shows how contributions of financial integration and monetary independence have increased from the first period to the last, with corresponding limitations on exchange rate stability. The analysis continues by exploring the implications of changes in the trilemma indices for macroeconomic outcomes. Accordingly, it reveals evidence that financial integration and monetary autonomy together with corresponding loss of exchange rate stability have impacts on growth volatility, inflation and inflation volatility throughout 1998-2010, though these effects might differ for each sub-period. Finally, it finds that there is a key role for raising international reserves as trilemma trade-offs and their effects on macroeconomic variables have been mitigated with their accumulation

• Item Type: MPRA Paper
• Language: English
• Keywords: Financial trilemma; Turkish economy; International reserves; Monetary policy; Capital account opening
• Subjects: F - International Economics > F4 - Macroeconomic Aspects of International Trade and Finance; F - International Economics > F3 - International Finance; E - Macroeconomics and Monetary Economics > E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit; E - Macroeconomics and Monetary Economics > E4 - Money and Interest Rates

References

Aizenman, J. (2010). “The Impossible Trinity (aka The Policy Trilemma)”, forthcoming in Encyclopedia of Financial Globalization (May).

Aizenman, J., M. Chinn and H. Ito, (2008), Assessing the Emerging Global Financial Architecture: Measuring the Trilemma’s Configurations over Time,” NBER Working Paper No. 14533 (December).

Aizenman, J., Chinn M. and Ito H. (2010). “Surfing the Waves of Globalization: Asian and Financial Globalization in the Context of the Trilemma,” NBER Working Paper No. 15876 (April).

Athans, M. (1974) “The Importance of Kalman Filtering Methods for Economic Systems”, Annals of Economic and Social Measurement, 2, 1974, 49-64.

Balkan, E., and Yeldan, E. (2002) “Peripheral Development Under Financial Liberalization: The Turkish Experience”, in N. Balkan and S. Savran (ed) The Ravages of Neo-Liberalism: Economy, Society and Gender in Turkey, New York: Nova Science Publication

Bouakez, H. and Rebei, N. (2007). “Why does Private Consumption Rise After a Government Spending Shock?” Canadian Journal of Economics, 40 (3), 954-979.

Central Bank of the Republic of Turkey, (2004). “Remarks by Governor”, www.tcmb.gov.tr, Access: December 2010

Cheung, Y-W. and Ito, H. (2007). “Cross-sectional Analysis on the Determinants of International Reserves Accumulation,” mimeo, UC, Santa Cruz.

Hutchison, M., Sengupta, R. and Singh, N. (2010). “India’s Trilemma: Financial Liberalization, Exchange Rates and Monetary Policy”, mimeo, University of California, Santa Cruz.

Kalman, R.E. (1960). “A New Approach to Linear Filtering and Problems”, Journal of Basic Engineering, 82, 35-45.

Obstfeld, M., Shambaugh, J. C. and Taylor, A. M. (2008). “Financial Stability, the Trilemma, and International Reserves”, NBER Working Paper 14217 (August).

OECD Reviews of Regulatory Reform in Turkey, 2002, “Enhancing Market Openness”, Report No. 40/9

Ramsey, J.B. (1969). “Tests for Specification Errors in Classical Linear Least Squares Regression Analysis,” Journal of the Royal Statistical Society, Series B, 31, 350-371.

Ramsey, J.B. and Alexander A. (1984). “The Econometric Approach to Business-Cycle Analysis Reconsidered,” Journal of Macroeconomics, 6, 347-356.

Watson, P.K. (1983). “Kalman Filtering as an Alternative to Ordinary Least Squares: Some Theoretical Considerations and Empirical Results”, Empirical Economics, Vol. 8, page 71-85.