Measuring exchange rate misalignment in Turkey

Abstract

Turkey has embarked an extensive dis-inflation and stabilization program in December 1999. The programme exclusively relied on a nominally pegged (anchored) exchange rate system for dis-inflation and on fiscal austerity. In February 2001, however, Turkey experienced a severe financial crisis which necessiated the dismantling of the exchange rate anchor and a switch to a regime of free float.

The underlying elements of the disinflation program and the succeeding crisis are discussed in detail in Ertuğrul and Yeldan (2003), Akyüz and Boratav (2002), Yeldan (2002), Boratav and Yeldan (2002), Ertuğrul and Selçuk (2001), Eichengreen (2001), Gencay and Selçuk (2001), and Alper (2001).

This article proposes a new methodology to measure exchange rate misalignment for Turkey over the period January 1992 to December 2001. In a single equation framework, the model estimates the real exchange rate within a time varying parameter model, where a return-to-normality assumption about the parameters is assumed. Contrary to common belief, it is found that, except the initial four months of the stabilization programme, the Turkish lira remained undervalued for most of 2000. Also, one observes a pattern where the lira has been overvalued after the financial crisis of 1994 until 1998, and has displayed a tendency of undervaluation after then.

Acknowledgements

The authors would like to thank Christopher Baum, Refet Gurkaynak, Faruk Selçuk, the participants of the 6th METU Conference on Economics, September 2002, Ankara and the colleagues at Bilkent University for their criticisms and suggestions on earlier drafts of the article. The authors are also grateful to Gül Biçer for her excellent research assistance.

Notes

The underlying elements of the disinflation program and the succeeding crisis are discussed in detail in Ertuğrul and Yeldan (2003), Akyüz and Boratav (2002), Yeldan (2002), Boratav and Yeldan (2002), Ertuğrul and Selçuk (2001), Eichengreen (2001), Gencay and Selçuk (2001), and Alper (2001).

See Edwards (2001). See also Fischer (2001) on the formal statement of the problem within the context of a finer classification of the exchange rate systems.

Rodrik and Velasco (1999) regard this ratio as the most robust indicator of a currency crisis. For comparison, at the outbreak of the financial crisis in Asia in 1997, this ratio was 60% in Malaysia; 90% in Philippines; 150% in Thailand; and 170% in Indonesia.

Note that we can also generalize the state equation to a p ^th order, Vector Autoregression (VAR) for the coefficient vector β_t by defining

and replacing the state equation accordingly.