How does the monetary transmission mechanism work? Evidence from Turkey

This paper reveals how monetary transmission works in Turkey under an explicit inflation-targeting regime implemented since the beginning of 2006. We build various vector autoregression (VAR) models and show that the central bank's main policy tool, interest rates, and the nominal exchange rate are determinant of output and the inflation rate, respectively. Among the external variables selected, the federal funds rate seems to have an impact on Turkish output, while asset prices and liquidity explain majority of the fluctuation in output over time. This study demonstrates that monetary policy is effective in Turkey, an emerging country, and broadens the current literature on monetary transmission in Turkey and other emerging markets. In addition, the paper employs a new approach by exploiting various VAR techniques, including SVAR, to understand and shed light on the functioning of monetary transmission channels in a more comprehensive framework.