Inflation, inflation uncertainty, and monetary policy in Turkey: 1960–1998

MARK J. PERRY [*] The authors constructed a time series of monthly inflation uncertainty in Turkey from 1960 to 1998 using GARCH models and investigated the link between inflation and inflation uncertainty using Granger tests. The authors found strong statistical support that inflation significantly raised inflation uncertainty in Turkey over the full sample period and three subsamples. The evidence on the effect of inflation uncertainty on average inflation is mixed and depends on the time period examined. An analysis of the political conditions and the record of macroeconomic policymaking in Turkey between 1960 and 1998 reveal institutional and political factors that can help explain the empirical results. (JEL E310, 1342, 1340) I. INTRODUCTION An extensive body of both empirical and theoretical literature focuses on the relationship between the rate of inflation and inflation uncertainty. Recent studies by Brunner and Hess (1993), Evans and Wachtel (1993), and Ball and Cecchetti (1990) found statistical support for a positive association between the rate of inflation and inflation uncertainty in the United States. Theoretical studies by Cukierman and Meltzer (1986), Cukierman (1992), and Ball (1992) address the issue of the direction of causality between inflation and inflation uncertainty. Ball claims that higher inflation creates greater inflation uncertainty, while according to Cukierman and Meltzer inflation uncertainty leads to higher average inflation due to opportunistic central bank behavior (politically motivated expansionary policy). Recent empirical work focuses specifically on the direction of causality between inflation and inflation uncertainty. Holland (1995) found that inflation raises inflation uncertainty in the United States and that higher inflation uncertainty leads to lower average inflation due to stabilization motives of policymakers. Grier and Perry (1998) showed that inflation significantly raises inflation uncertainty in all G-7 countries but that increased inflation uncertainty raises inflation only in Japan and France. Evidence of stabilizing behavior is found in the United States, United Kingdom, and Germany, where increased inflation uncertainty lowers average inflation. In the present study, following the methodology used in Grier and Perry (1998), we constructed a time series of monthly inflation uncertainty in Turkey from 1960 to 1998 using generalized autoregressive conditional heteroskedastic (GARCH) models and investigate the link between inflation and inflation uncertainty using Granger tests. This article found strong statistical support that inflation significantly raises inflation uncertainty in Turkey over the full sample period and three subsamples, confirming the prediction of Ball (1992). Test results for whether inflation uncertainty lowers or raises subsequent inflation are mixed and depend on the time period tested. Overall, stabilizing policy behavior seems to prevail, especially in the long run, since higher inflation uncertainty is associated with lower average inflation at some lag lengths in each sample period investigated. This article found evidence of opportunistic policy behavior in the short run during the late 1980s and 1990s, when inflation uncer tainty raised average inflation. An examination of the political conditions and the record of macroeconomic policy making in Turkey between 1960 and 1998 reveal institutional and political factors that explain our empirical results. Section II reviews the theoretical and empirical literature on the relationship between inflation and inflation uncertainty. Section III discusses measures of inflation uncertainty and shows how GARCH models can be used to construct a time series measure of inflation uncertainty. In sections IV and V the authors present empirical results and discuss how the policy environment in Turkey over this period can help explain these findings. Conclusions are presented in section VI. …