Exceptionally loose monetary policies adopted by advanced economies to eliminate the downside risks on economic activity not only boosted global liquidity but also stimulated the search for yield, which encouraged more capital flows into emerging economies. Moreover, the weak recovery in developed economies – Turkey’s main export destinations, dampened foreign demand growth (Figure 2). Low interest rates across the globe, soaring imports driven by strong credit growth amid increased short-term capital inflows, and weaker foreign demand caused the current account deficit to widen rapidly in 2010. All of these developments prompted the CBRT to adopt a strategy, which partly targets financial stability besides the main objective of price stability, parallel to the conditions referred to as the “new normal”. In this context, as stated previously, the CBRT has actively begun to use tools such as required reserves and liquidity management, in addition to the one-week repo auction rate, the main policy instrument. 1. Inflation developments  Having summarized the global economic conditions and the implications of this outlook on the monetary policy, I would now like to inform you about the inflation developments of the last quarter. As you will recall, we underlined in the October 2010 Inflation Report that the increases in unprocessed food and tobacco prices – which are beyond the immediate control of the CBRT – added about 5 percentage points to annual inflation, and suggested that these items would leave sizable room for disinflation. Indeed, inflation dropped by 2.83 percentage points, yielding a rate of 6.4 percent, meeting the year-end inflation target.

Moreover, the report also incorporates a study that examines recent developments in foreign exchange and derivatives markets by relating them to monetary policy decisions. Two boxes also clarify the new policy approach we are currently implementing. The former discusses the place of the reserve requirements in the monetary policy and its channels to influence economy, while the latter discusses the relationship between price stability and financial stability within the context of the inflationtargeting regime. Lastly, the sources of our revisions of inflation forecasts during 2010 are explained in a study that we designed within the context of our liability of accountability. Before moving on to the Central Bank’s assessments of inflation outlook and economic activity, which I will cover in detail shortly, I would like to summarize the current global conditions that continue to be determinant of the domestic economic outlook. The world economy continued to recover gradually in the final quarter of 2010, while downside risks remained a major concern for advanced economies. Financial institutions, firms and households in advanced economies are still undergoing the process of balancesheet repair, limiting the contribution of private consumption and investment to the economic recovery. On the other hand, the relatively less affected emerging economies are recovering steadily amid robust domestic demand (Figure 1). BIS central bankers’ speeches  1  This growth discrepancy between advanced and emerging economies and its implications for the Turkish economy became the key determinants for the Central Bank of Turkey’s (CBRT) monetary policy strategy in the fourth quarter.