Inflation Targeting and Exchange Rate Dynamics: Evidence From Turkey

This paper examines the constraints on the dynamics of the daily US dollar and the Euro exchange rates relative to the Turkish lira after the full fledged Inflation Targeting regime was adopted in 2006. We find that the single threshold specifications with two regimes that allow the conditional variance as well as the conditional mean to vary exhibit different dynamics in each regimes and produce superior forecasts below the threshold levels of the model for both the Euro and the US dollar than the forecasts produced by a random walk model. As a result, we conclude that the dynamics of the daily exchange rates are more constrained at the lower levels of the exchange rates and thereby embed a predictable process during the inflation targeting period in Turkey.