The largest contribution to annual growth in the third quarter came from private sector demand through consumption and investment; whereas, due to the contraction in exports and the acceleration of demand for imported goods, the net foreign demand contributed to annual growth negatively. Thus, the divergence between domestic and foreign demand growth has become evident (Figure 18). BIS central bankers’ speeches  9  Recent data releases indicate that the third-quarter slowdown in economic activity is temporary. The composition of economic activity suggests that the divergence between domestic and foreign demand continued in the fourth quarter. Domestic demand for imported goods accelerated in the last quarter amid rapid credit expansion and lagged effects of the appreciation of the Turkish lira in the third quarter. As a result, the current account balance continued to deteriorate (Figure 19). The slow recovery in the global economy continues to restrain economic activity, whereas the strong domestic demand bolsters aggregate demand growth. In fact, the sharp upward trend in private consumption and investment spending that started in the fourth quarter of 2009 continued into the fourth quarter of 2010 (Figure 20). Continued economic recovery fueled by robust domestic demand has supported the gradual improvement in employment conditions. The rapid recovery in non-farm employment paused in the third quarter of 2010, which appears temporary, as suggested by leading indicators  10  BIS central bankers’ speeches  (Figure 21). However, due to high labor force participation rates, it will take a while before unemployment rates come down to precrisis levels (Figure 22).

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.