Exchange rate policy and price level changes: Casualty tests for Turkey in the post‐liberalisation period

Abstract

The purpose of the present study is to examine the relationship between exchange rate changes and price level changes in Turkey during the 1980s using some modified Granger causality tests. During this period, Turkish exchange rate policy was characterised by considerable flexibility, in contrast to the long‐standing policy of fixing the exchange rate until a foreign exchange crisis necessitated devaluation. The weight of the evidence presented suggests that Granger causality runs from price level changes to exchange rate changes but that there is not feedback causality from exchange rate changes to price level changes. This conclusion is not altered by the inclusion of a money supply variable. Thus, for Turkey, exchange rate adjustment does not seem to have created a vicious cycle of currency depreciation leading to inflation as is often feared. Whether this result will hold for other developing countries which adopt flexible exchange rate regimes will require further testing.