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Working Paper / Research Division Turkey/CATS

With the global rise in authoritarianism, there has been an increase in political commentaries by the populist leaders that have criticized their central banks in favor of lower interest rates. We analyze the effects of these political pressures on exchange rates. We provide strong empirical evidence where political commentaries affect both the level and the volatility of exchange rate returns. The intensity of political pressures as well as institutional strength play a key role in determining the size of the impact.

Despite the mounting costs of the pandemic at the global scale, the country-specific costs were rather heterogenous. National performances varied depending on the restrictive measures adopted, institutional strength, as well as adherence to stringency measures. We illustrate that obedience and rule of law strengthen the performance of the containment measures.

COVID-19 pandemic had a devastating effect on both lives and livelihoods in 2020. The arrival of effective vaccines can be a major game changer. However, vaccines are in short supply as of early 2021 and most of them are reserved for the advanced economies. We show that the global GDP loss of not inoculating all the countries, relative to a counterfactual of global vaccinations, can be higher than the cost of manufacturing and distributing vaccines globally. We use an economic-epidemiological framework that combines a SIR model with international production and trade networks. Based on this framework, we estimate the costs for 65 countries and 35 sectors. Our estimates suggest that up to 49 percent of the global economic costs of the pandemic in 2021 are borne by the advanced economies even if they achieve universal vaccination in their own countries.

The COVID-19 crisis can turn into the biggest emerging market (EM) crisis ever. EMs observed the financial shock first, with the tightening global financial conditions. They will soon experience the full wrath of the perfect storm with possibly much larger spill-back effects for the global economy. This paper focuses on a large representative EM, Turkey, with low foreign currency reserves, high foreign currency debt and a questionable record on policy credibility. The pandemic has already led to a substantial decline in economic activity and Turkey's policy options are more limited given its low fiscal space and its reliance on capital flows. We estimate the costs and benefits of a full lockdown and offer policy recommendations that will help to avoid an economic meltdown. In order to prevent a 2001 style crisis, the best option is to consider an immediate lockdown and subsidize the economy. The external funding that is necessary for the economic relief package should be secured through international financial institutions rather than imposing capital controls. Domestic funding should be provided with a well targeted and transparent asset purchase program by the central bank.

Central bank credibility is critical for the effectiveness of monetary policy. The measures of credibility that are based on the changes in actual inflation rate do not perform very well in environments of chronic inflation. We design an alternative measure that allows us to track the evolution of credibility in an inflationary environment. Credibility is defined as the central bank's ability to lower inflation expectations towards its inflation target via current interest rate decisions. We adopt a Bayesian set up to exploit this definition and document how credibility changes over time. Our measure differs from the existing measures that are based on the deviation of inflation expectations from the inflation target. We show that the latter tests may be too blunt in the EM context and either overlook marginal improvements in credibility or incorrectly attribute the temporary reductions in the inflation rate to improvements in credibility. Utilizing a time varying parameters modeling structure, we show that the credibility of the Central Bank of the Republic of Turkey (CBRT) has declined significantly over time. Potential reasons for this deterioration could be the CBRT's disappointing performance in hitting the inflation target and its exposure to political pressures. We apply our methodology to Brazil as well to highlight its advantages and draw a comparison to the existing literature.

Negative interest rate policy (NIRP) is associated with a particular friction. The remuneration of banks' retail deposits tends to be floored at zero, which limits the typical transmission of policy rate cuts to bank funding costs. We investigate whether this friction affects banks' reactions under NIRP compared to a standard rate cut in the euro area. We argue that reliance on retail deposit funding and the level of excess liquidity holdings may increase banks' responsiveness to NIRP. We find evidence that banks highly exposed to NIRP tend to grant more loans. This confirms studies pointing to higher risk taking by banks under NIRP and contrasts results that associate NIRP with a contraction in bank loans. Broader coverage of our loan data and the explicit consideration of banks' excess liquidity holdings are likely reasons for this different result compared to some earlier literature. We are the first to document the importance of banks' excess liquidity holdings for the effectiveness of NIRP, pointing to a strong complementarity of NIRP with central bank liquidity injections, e.g. via asset purchases.

This study examines the effects of price adjustments in the tobacco sector on inflation in Turkey. The findings show that the taxes on tobacco products increase inflation in the short-term. However, the effect is rather limited, a 16 basis points increase in inflation if the current 65.25% Special Consumption Tax (SCT) increases by 25 basis points. Factors that cause inflation in the long-run are cost and demand. The cost-driven impact of tobacco prices on inflation is rather limited due to the low weight of this product in the consumption basket. Nevertheless, the structure of the tax multiplier used in tobacco taxation increases cigarette prices in a non-linear fashion and, therefore, has the potential to disrupt inflationary expectations.