Central banks can do this by anchoring inflation expectations through establishing a good track record and by demonstrating that the central bank adjusts its policy rates appropriately in response to the changes in the inflation outlook. This behavior is known as the central bank reaction function. That is to say, in order to keep the inflation in line with the target, the central banks react to economic news in a more or less predictable manner. As economy changes over time, the available data set also changes. We get some of our guidance from the analysis of these data by using models or econometric tools. Models are useful but they are not sufficient; in formulating our decision we do and must put some weight on judgments as well. This is known as the art side of the monetary policy. Central Bank of Turkey has been able to bring down inflation from 70 % in 2001 to 7.7 % at the end of 2005. Although the structural reforms over the last five years have been critical in the fight against inflation, the new monetary framework of inflation targeting also played an important role. Inflation expectations have somewhat been successfully anchored to the target, notwithstanding some deviations and deteriorations lately. At the end of May 2007, the Central Bank of Turkey is faced with a considerable credibility gap.
It was enacted on June 11, 1930 as the Law on the Central Bank of the Republic of Turkey. Accordingly, the Bank started to operate on October 3, 1931 and Mr. Selahattin Çam was appointed as the first General Director, or as we now refer to, as our first Governor. The Law did not involve any explicit provision for the independence of the CBT. However, this did not mean that Lawmakers then did not have any idea about the relationships among money, politics and price level. On the contrary, the founders of the Republic were fully aware of the idea that a central bank should be independent in order to get the best outcome from its policies. Let me quote, for example, _smet _nönü, the Second President of the Republic, in one of his various speeches on the establishment of the Central Bank; “I knew from the very start that the Central Bank had to be an independent institution, operating with the integrity and robustness that would be required against even the Government and the Ministry of Finance, let alone its relations with other private banks”. The law did not stipulate any provisions for granting short term advances to the government to prevent the use of the Central Bank resources for financing government expenditures, and thus to avoid inflation and to maintain fiscal discipline. These are enough evidence that despite no formal provisions for the independence, the CBT was de facto an independent authority in conducting monetary policy.