The amendments made in the Law of the Central Bank of Turkey in 2001 have been a turning point and instrumental for the efforts to maintain macroeconomic stability. With these amendments, achieving and maintaining price stability is stated as the primary objective of the Central Bank and the Bank acquired its instrumental independence. In fact, the independency has given the Bank the opportunity to set its policies for longer terms, free of political cycles and pressures. As an assurance given to the public to ensure the long term price stability objective, the independence of the Central Bank of Turkey together with its transparent and effective communication policy have increased the credibility of the monetary policy. Besides, the new monetary policy framework implemented first as implicit and then as full-fledged inflation targeting regime together with the floating exchange rate regime have contributed a lot to the decline in dollarization since 2002, as the literature 10 suggests. In this respect, we can observe the findings of the portfolio approach in Turkey very clearly. To be more specific, the volatility of exchange rates has increased due to floating exchange rate regime on the one hand and inflation and its volatility have declined significantly on the other.
Given the fact that the policy rate is an inadequate tool to deal with overleverage, excessive risk taking, or apparent deviations of asset prices from fundamentals, there are other instruments at the policymaker’s disposal: countercyclical regulatory tools. Thus, if leverage appears excessive, regulatory capital ratios can be increased; if liquidity appears too low, regulatory liquidity ratios can be introduced and, if needed, increased; to dampen housing prices, loan-to-value ratios can be decreased; to limit stock price increases, margin requirements can be increased. As I said earlier, the NBR has always had to juggle the “three aspects of stability” and that called for the deployment of alternative instruments, such as the full use of the reserve requirement ratios and recourse to administrative measures. Reserve requirement ratios were increased up to 20 and 40 percent for lei- and forex-denominated liabilities respectively, and the list of administrative measures included: enforcing a maximum loan-to-value ratio, introducing debt service ceilings relative to households’ monthly disposable income, setting limits on banks’ forex exposure vis-à-vis unhedged borrowers, using differentiated coefficients in stress tests (higher for exposures to EUR than lei, with even stricter coefficients for CHF- and USD-denominated credit). Even though at the time our modus operandi was seen as deviating from the orthodoxy of central banking, during the global crisis or in its aftermath, macroprudential instruments are now part of the mainstream and forex interventions re-entered the arsenal of many central banks, including some of those using a free floating regime before the crisis.