Anchoring of Inflation Expectations: The Case of Turkey

It may be observed from the existing monetary economics literature that none of the previous papers that examine the degree to which inflation expectations are anchored in Turkey takes structural breaks into account. However, it is widely accepted that an economy is likely to be exposed to some considerable events/structural breaks. Hence, the previous research may have provided inefficient and biased output about anchoring of inflation expectations in Turkey. To fulfil this gap to some degree, the purpose of this paper is to investigate whether inflation expectations are well anchored in Turkey considering the structural breaks. To this end, the paper first uses the original model of Bomfim and Rudebusch (2000) and then extends this model with the exchange rate. Monthly data over the period 2004:2-2019:7 are used. In the paper, first, the stationarity levels of the variables are examined, and it is found that all variables are stationary at first differences. Subsequently, considering the recent developments in cointegration analysis, the paper employs the Tsong et al. (2016) cointegration test based on the Fourier approximation and the dynamic ordinary least squares estimator suggested by Saikkonen (1991) and Stock and Watson (1993) to examine whether there is a cointegration relationship among the variables in the empirical model. Finally, after detecting the presence of cointegration, the paper estimates the long-run coefficients. The findings show that the sensitivity of inflation expectations to the inflation rate in the previous period is higher than that to the inflation target for the original model. Besides, the findings obtained from the extended model imply that inflation expectations are most affected by the exchange rate. These results provide evidence that inflation expectations are not well anchored in Turkey.