Furthermore the pattern of economic growth has changed. Today, the main sources of growth are the improvement in productivity and increasing export performance. In addition to this, the role of the private sector in economic growth has increased considerably in the last few years. Recent Turkish experience showed that tight and prudent fiscal policy is not necessarily contractionary, especially if and when an economy is facing fiscal dominance. The economy is expected to keep its growing trend in 2006 and onward and the aim obviously is to achieve sustainable growth rates at high levels. 2  BIS Review 19/2006  Secondly, substantial progress in financial stability has been achieved with the help of the restructuring of the banking sector. Financial markets are now deeper and much less fragile. Parallel to these achievements, both nominal and real interest rates have declined significantly. The average maturity of the Treasury issues increased considerably and Turkish Eurobond spreads, used as a proxy for the country risk premium, have dropped significantly since 2001. Volatility in exchange rates has gradually decreased thanks to the transparent and consistent operation of the floating exchange rate regime. All these together triggered the reverse-dollarization process: Though the process has been interrupted from time to time and more progress is necessary, the weight of Turkish lira denominated investments in portfolio preferences is now on an upward path. And finally, integration of the Turkish economy with the world has increased, leading to a more competitive environment in the real sector.

In this context, the floating exchange rate regime was introduced; the Central Bank Law has been amended and the primary objective of the Central Bank has been, for the first time in its history, defined as achieving and maintaining price stability. Together with these changes, a new economic program entitled “Strengthening the Turkish Economy-Turkey’s Transition Program” was launched in May 2001. This new program addressed the two main issues of chronic inflation and high public debt with tight monetary and fiscal policies backed up by structural reforms. In this environment, the Central Bank needed to introduce a transparent monetary policy regime with a clear nominal anchor to shape inflation expectations, as inflation inertia was the biggest problem and authorities lacked credibility. The choice of the exchange rate as a nominal anchor again was out of question: The exchange rate based stabilization program had been abandoned in total loss of confidence. The other option then could be to use monetary aggregates as a nominal anchor. However, they too were not good candidates for a couple of reasons: One, monetary targeting implicitly incorporates the inflation target as the ultimate objective of monetary policy and relies on a forward looking assessment when responding to shocks; the pure form of this regime considers only money and ignores the potential information contained in non-monetary variables. Two, the success of the monetary targeting regime relies on the two assumptions that the velocity of money is entirely predictable and inflation is solely determined by money growth.