Estimating taylor rules with markov switching regimes for Turkey

Abstract

This study examines the alternative specification of monetary policy rules during inflation targeting regime in Turkey. Original Taylor rule and Taylor rule augmented with exchange rate are estimated using the Markov regime switching models. We use monthly data for the period 2003:1-2017:7. Our findings indicate that the Turkish economy operates in two different regimes: high-interest rate regime (high regime) and low-interest rate regime (low regime). In both models, 2009 is the clear-cut year of transition between two regimes. Findings indicate both regimes to be permanent. The response to inflation in the high regime is larger compared to its low regime counterpart. A key finding is that in the high regime, the reaction to output gap is more aggressive than the reaction to inflation. This implies that, according to Central Bank of Republic of Turkey, output gap stabilization is more important than inflation stabilization.