The Developing Economies, XLI-4 (December 2003): 401–35

401

EFFECTS OF THE REAL EXCHANGE RATE ON OUTPUT AND INFLATION: EVIDENCE FROM TURKEY
HAKAN BERUMENT MEHMET PASAOGULLARI

This paper assesses the effects of real depreciation on the economic performance of Turkey by considering quarterly data from 1987:I to 2001:III. The empirical evidence suggests that, contrary to classical wisdom, the real depreciations are contractionary, even when external factors like world interest rates, international trade, and capital flows are controlled. Moreover, the results obtained from the analyses indicate that real exchange rate depreciations are inflationary.

I.

INTRODUCTION

interest among academics and policymakers on the controversial issue of exchange rate policies in general and exchange rate regimes and real exchange rates in particular. The effects of financial crises on the global economy are getting more severe, and international trade and capital movements have begun to be central factors in the evolution of such a crisis. Domestic factors that lead to crises in various countries are different, but there are also common features of these crises: big devaluations or depreciations in domestic currency and the subsequent significant output losses of the crisis-hit countries. Turkey has often experienced financial crises in its history. In 1994 and 2001, the nominal domestic currency depreciated 62 per cent and 53 per cent, respectively. This made the effects of large depreciations an interesting event to study and also provided a natural laboratory where the effect of depreciation on economic performance could be observed. Starting in 1987, in a managed float exchange rate regime, the Central Bank of the Republic of Turkey (hereafter, the CBRT) announced daily quotations, and the domestic currency was depreciated continuously parallel to inflation expectations.