Time-Varying Exchange Rate Pass-Through in Turkey: A DCC GARCH Analysis

Abstract

Ensuring price stability is one of the basic conditions for the effectiveness of a market economy and changes in the overall level of prices affect the economy through different channels. The exchange rate is also one of the most important factors affecting domestic prices and causes inflation. The concept known as Exchange Rate Pass-through (ERPT) is defined in the economic literature as the reflection of changes in exchange rates on domestic prices by affecting import and export prices. Especially in countries that are open and aim to implement inflation targeting policy, the ERPT level is one of the most important phenomena that should be considered by decision-makers. Many studies in the literature examine this topic empirically and recently some studies have also focused on the time-varying nature of ERPT.The arguments of the relevant studies are that the monetary positions of the economies that is, inflation, are not constant, thus the level of ERPT can also change over time. The main aim of this thesis is to analyze the changing nature of ERPTover time for the Turkish economy, which applies inflation targeting policy. For this purpose, the dynamic conditional correlation DCC-GARCH method was used with monthly data in the periods 1990:3 and 2019:12. According to the results of the model forecast, it was observed that the level of ERPT was high in the 1990s when high inflation was observed in Turkey, and in the last decade, it remained lower with relatively low inflation rates. The results obtained in this context support Taylor (2000)‟s hypothesis and show that the level of ERPT varies over time.