and growth was not satisfactory. aside from short - lived periods of relative stability, loose fiscal policies along with accommodative monetary policies were the main causes of high inflation. under these circumstances backward indexation became a common practice in pricing behavior ; inertia evolved in inflation, which was very difficult to eliminate. as inflation increased, inflation expectations also increased and a self - nurturing inflation cycle began. in the meantime, there were number of attempts to get out of this impasse. first, there was a monetary program introduced in 1990. this was very important in that it reorganized and re - structured the central bank balance sheet and explained to the financial community and to the general public how the monetary policy operated. it was the first time when certain monetary concepts like base money or central bank money were brought to the attention of the public. however external developments like the first gulf war brought this program to an end. the second major program for disinflation was the exchange rate based stabilization program of 2000 under the imf support. this program collapsed for known reasons in february 2001. at this juncture, one might wonder why turkey was not successful in her disinflation attempts. i believe the answer lies, as already mentioned, in the lax fiscal policies. as i have already mentioned the very first law of the central bank did not have any provision for financing the government. however the amendment made to the law just before the second world war to extend temporary short - term advance facility to the government, in order to smooth out the difference between timing of taxes and expenditures, was firmly incorporated in its law in 1970. the provision stipulated that the government had the access to the central bank financing to the tune of 15 % of the total budget spending. although this facility was phased out after the 1994 crisis, it was one of the reasons of fiscal indiscipline and high and persistent inflation in turkey. as we all know, tough times call for tough decisions. the collapse of exchange rate - based stabilization program in 2001 was, in one sense, an opportunity for turkey to “ put her house in order ”. the fiscal cost of the crises brought every individual in the economy to his senses. fiscal discipline and tight monetary policy were the immediate answers to the chronic problems of turkey. but how would this discipline be achieved? the answer lied, and still lies in building a chinese wall between the central bank and the treasury in terms of government finances, by means of an independent central bank.

the stable prices : the central banks. therefore the bottom line of the inflation - targeting regime is the management of the expectations. if expectations are anchored to the target, wage earners and price setters will behave in such a way that, at the end of the period, the target will be reached. then the question is, how can we anchor expectations? the answer is : by building credibility through delivering what is promised. once this is achieved, the volatility in interest rates, inflation and output would be lower. how do we build credibility? central banks can do this by anchoring inflation expectations through establishing a good track record and by demonstrating that the central bank adjusts its policy rates appropriately in response to the changes in the inflation outlook. this behavior is known as the central bank reaction function. that is to say, in order to keep the inflation in line with the target, the central banks react to economic news in a more or less predictable manner. as economy changes over time, the available data set also changes. we get some of our guidance from the analysis of these data by using models or econometric tools. models are useful but they are not sufficient ; in formulating our decision we do and must put some weight on judgments as well. this is known as the art side of the monetary policy. central bank of turkey has been able to bring down inflation from 70 % in 2001 to 7. 7 % at the end of 2005. although the structural reforms over the last five years have been critical in the fight against inflation, the new monetary framework of inflation targeting also played an important role. inflation expectations have somewhat been successfully anchored to the target, notwithstanding some deviations and deteriorations lately. at the end of may 2007, the central bank of turkey is faced with a considerable credibility gap. our strong reaction in 2006 have contained inflation expectations and we predict that inflation expectations will continue to move towards the medium term target of 4 percent as the headline inflation comes down in the next couple of months. however, it should be noted that there are also other important factors in determining the inflation expectations, such as incomes policy and the course of fiscal policy, or political aspects, etc. apart from short - term interest rates, communication skills are also critical tools in guiding the expectations towards the target. what we do is important, but equally important is how we convey this to our target audience. that is not only what we communicate but also to whom we communicate. of course the target audience of