of the exchange rate policy to be conducted in the framework of the regime is under the authority and responsibility of the central bank. the essence of the floating exchange rate regime is that the value of the turkish lira against foreign currencies is formed under market conditions and according to developments in supply and demand conditions. in this respect, the central bank conducts two kinds of transactions in markets : firstly, the central bank purchases foreign exchange to build up reserves. these purchases are made via fx purchase auctions. in 2006, the daily purchase amount for these auctions including options is usd 60 million. these auctions were suspended on may 16, 2006 due to market conditions and the decline in fx supply. when the conditions for these auctions mature, they will be resumed. as a result of our strategy to increase reserves, which is applied in this framework, the amount of our reserves reached usd 60 billion as of may 26, 2006. secondly, the central bank conducts interventions due to volatility. taking into account the factors that cause volatility in either direction or potential developments, the central bank may intervene directly in the market or use announcements and warnings. these implementations do not have a mechanical nature. as the conditions of each intervention differ from each other, neither do they have a symmetrical nature. at this point, i would like to share my views about the activity observed in the value of the turkish lira lately. the international liquidity conditions, which change according to the monetary policies pursued by the central banks of developed countries, and the perceptions of uncertainty that emerged due to internal and external developments, had considerable effect on the exchange rate movements that have been observed almost for a month. in the short term, this activity is perceived to be more negative than the information it contains. however, there is no deterioration in the macroeconomic fundamentals. there is no change in the program projections and targets. the movement of the exchange rate is mainly caused by external developments. similar movements are observed in other developing countries, as well. today, the floating exchange rate regime performs its shock - absorbing function. we have observed similar developments in the past five years, as well. exchange rates displayed similar fluctuations and movements in the short term, surpassed their immediate levels, but the main tendency did not change. due to the nature of the floating exchange rate regime and the exchange rate policy, similar movements may also be observed in the future, as a result of similar or different factors. the similar impacts of internal and external

projections that foresee even higher prices in the near future. as a matter of fact, many countries under inflation targeting regime now project that inflation will converge to the target at end - 2009 or in 2010, at the earliest. going through a long period of high inflation is a serious risk for price stability. first, the general price level may shift upwards at a faster rate, as producers and workers in other sectors ask for higher prices and wages in response to the loss of their real purchasing power. the fall in real interest rates due to deterioration in inflation expectations is another risk, since lower real rates will lead to a faster pace of credit expansion. the common factor of these two risks is that persistent supply shocks may turn into demand shocks after a while. thus, at some point, central banks have to decide to what extent they can tolerate the rise in inflation. as the famous philosopher karl popper put it while defining the demarcation problem, “ if we do not demarcate a scientific hypothesis, we will be leaving out one of the key steps in verifying the correctness of that hypothesis ”. any theory should be formulated in a way to allow falsification ; the circumstances under which the theory fails should be identified. advocators of a “ wait - and - see ” approach in the face of supply shocks are not clear on the question of when the supply shock ends and when demand - driven price increases take its place, in an environment where inflation keeps rising. if this issue is not clarified, any abovetarget inflation figure or any upward revision in inflation forecasts can easily be attributed to supply - side factors. clear lines should be drawn as to which economic data would refute this discourse and what would constitute a limit to supply shocks from a central banker ’ s point of view. dear guests, in this part of my speech, i would like to discuss recent developments in the turkish economy and the monetary policy implemented in this period. i believe that starting this evaluation with the developments in 2006 will be more useful in providing a better understanding of the current monetary policy stance. as you may know, in may 2006 risk perceptions for developing countries changed significantly owing to the deterioration in global liquidity conditions. in the period where the supply - side shocks started to take their toll on inflation, the rapid depreciation of turkish lira led to a significant deterioration in medium and long - term inflation expectations – giving rise to the risk of potential second - round impacts. the central bank