The causality analysis of the relationship between inflation, interest rate and exchange rate in turkey

The aim of this study was to investigate the relationship between inflation, interest rate, and exchange rate in Turkey for the period between 1984 and 2017. In line with this aim, firstly the effect of the relationship between these variables on the Turkish economy through monetary transmission mechanism was explained and theoretical information was presented. Then, the relationship between inflation, interest rate, and exchange rate was analyzed by OLS method and investigated using the Toda–Yamamoto (TY) causality test. Toda - Yamamoto (TY) causality analysis has some advantages compared to other methods of causality analysis. In this analysis, since variables do not have to be stationary at level, information loss caused by taking difference is prevented. In order to perform Toda - Yamamoto (TY) causality analysis, firstly, the stationarity test is performed on variables and the maximum order of integration (dmax) is determined. Then, taking into account the information criteria, such as AIC and SIC, the augmented VAR model is estimated at level by determining estimated order level [k + (dmax)] with the optimal lag length (k) for the variables. According to the results obtained from the study, in Turkey, 1984 - 2017 period, it is determined that there is one way causality, from interest rate to inflation, between inflation, interest rate and exchange rate. This result shows that interest rate is an important monetary policy instrument affecting inflation. For this reason, it can be said that taking into account the effect of interest rates will be beneficial while the inflation targeting policy, which has been implemented by the Central Bank since 2002, is maintained.