Relationship Among Exchange Rate, Inflation, And Economic Growth Literature Review
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According to the international journal of economics sciences reports, the official exchange rate is the exchange rate system that is mostly accepted and provided by the national authorities and officers to legally sanctioned exchange systems in the market. In most cases, it is calculated as an annual average rate especially in terms of monthly local currency units such as U.S dollar. Historically, after the fall of the Bretton Wood systems in early 1971, majority of global industries and economies including Turkey adopted a fixed exchange rate especially the use of monetary policy systems. Despite this, the volatility of monetary policy systems as the main exchange rate usually promotes inflation in the economy to a number of countries globally. In order to attain stable and strong economic growth of various countries such as Turkey, policy makers should provide proper and stable price systems in order to promote exchange rate constancy in the economy.
However, the Journal of Business research based literature reviews and studies also indicate that non-monetary procedures such as productivity shocks, government spending activities as well as trade policies and total foreign products are some of the major factors that control exchange rate systems of the market systems. This is because it usually causes exchange rate uncertainty thus leading to uncertain environment for investment. In most cases, this also negatively influences the international exposure of the country exports and import practices.
In Turkey, one of the major exchange rate problems and practices that have been recently witnessed include exchange rate devaluation systems. This has influences the balance of payment procedures in the country including the balance of trade, the export and imports activities as well as international competitiveness of the country local products and other international investment operations in the country. Factors such as market and import liberalization, tariff reduction, deregulation as well as denationalization have also negatively influenced the economic growth of the country.
In that sense, the main purpose and aim of this paper is to provide an evaluation and a description of the relationship among exchange rate systems, inflation and economic growth especially in Turkey. The paper will also provide research based literatures including the major variances of exchange rate especially in Turkey during the period of 1983 to late 2013. The paper will focus and involved a number of empirical and theoretical evidences in order to support and indicate the relationship between inflation and economic growth of Turkey for the period of around early 1983 to late 2013.
The Relationship among Exchange Rate, Inflation and Economic Development
Turkey is one of the global countries with the fastest growing economy especially in regard to its unique exchange rate systems. Furthermore, as emerging economy the country also has strong experience in terms of the relationship of its inflation and exchange rate practices. Unlike developed countries, the country experiences various effects of exchange rate fluctuations that mostly promote inflation changes in the market. In most cases, inflation dynamics in the economy usually influence other macro-economic variable including consumer and producer prices fluctuations. There are also various factors that influence the economic development of the country including its open marketing and trade systems. Therefore, policy makers in the country should provide stable and strong exchange rates in order to reduce and control low and stable inflation systems in the country. This will also provide effective domestic prices of goods and services in the local markets in the country.
According to the Journal of International Financial Markets of research publications, there is direct link between exchange rates and domestic prices of goods and services. For example, in most cases a change in import prices of goods and services usually causes around one percent change in the exchange rates. The provision of stable exchange rates and prices of goods in the economy usually results into low inflations thus leading to economic development of the country.
In early 1970s, Turkey was mostly using fixed exchange rate regimes. However, flexible exchange rates policies were later adopted in the country especially by various law makers and economists in the country. In most cases, real exchange rates determine the inflation patterns of an economy especially in relation to the competitive power of the country’s foreign trade systems. A number of research based reports and policies from the Central Bank in Turkey also indicate that sound monetary policies is very imperative towards the implementation of proper and good exchange rates in the country.
A number of variances usually influence the exchange rate and inflation systems of a country including the exchange rate shocks to domestic inflation systems. However, in Turkey it is clear that under inflation targeting policies and activities as well as exchange rates operations mostly do not appear in the country monetary policy procedures. Exchange rate fluctuation has been witnessed in Turkey since 1983 and there is need for the provision of macro-economic variables and policies that will reduce inflation rates through different market and trade based channels.
Exchange rate pass through activities is very imperative towards the provision of low inflation targeting regime in all countries globally and should be adopted by developing countries such as Turkey. Furthermore, a number of empirical as well as theoretical based studies and publications indicate that Turkey government is employing free floating exchange rate systems and this has improved its economic development and growth over the past years. The main currency used in Turkey is Turkey Lira. The relationship between exchange rates and domestic prices of local goods and services usually determine the inflation rate in the economy especially due to appreciation ad depreciation of the country currency systems. The use of Turkish Lira as the main currency for exchange rate mostly increases the inflation rate in the country. This is because it is a weak currency when compared to other currency systems such as U.S dollar.
In developing countries, monetary policies and inflation rates are usually very high and volatile especially over an extended period of time this producing economic crisis and problems. In that sense, the provision of fixed exchange rate systems can be employed in order to control and reduce high inflation rates in the country. Adoption of free exchange rate can also be employed towards the reduction of high inflation rates in the country in order to promote economic development and growth of the country. There are also periods when non-tradable goods and services in the country provided excessively high prices leading automatic indexation operations in the economy.
Recent research studies and reports from Journal of International Financial Markets also indicate that Turkey exchange rate and economic development is stable especially due to the adoption of the free floating exchange rate system. The inflation targeting policy was implemented in Turkey in early 2006 and this has promoted stable and proper economic growth of the country. In order to promote this policy and economic development of the country, there is need for the provision of high levels of credibility, transparency as well as accountability in the economic and social development systems of the country. This will promote the country inflation targeting strategy that usually provide and improve stable exchange rate systems. According to reports from the Central Bank in Turkey, the provision of flexible inflation targeting policy and other interest rates and market interventions can help in promoting the financial and price stability in the economy of the country. There have been a number of real depreciation on the economic performance of Turkey in the last decade and this is mainly due to world trade policies such as interest rates, international trade patterns as well as due to capital flows and tariff control systems.
The early 1997 economic crisis in Asian countries led to the introduction and adoption of a number of exchange rate policies including real exchange regimes. This was mainly adopted in order to promote global trade and international capital flows. The major factors that led to the early 1997 financial crisis include heavy devaluation systems, high depreciation in the domestic currency as well as other output losses in various developing countries globally.
Amity Global Business Reviews and publications, also indicate that Turkey has experience a number of economic and financial crises including the 1994 to late 2001 nominal domestic currency depreciation from sixty two percent to fifty three percent. The 1994 to early 2001 financial crisis in Turkey was mainly due to high depreciation in the domestic currency leading to high losses and other sharp devaluation systems in the economy. In late 1999, there was stable real exchange rate in Turkey due to proper capital flow in the country. This promoted economic development and growth in the country leading to high GDP and low inflation rates. However, in early 200 and late 2001 the country experienced high financial crisis leading to banking liquidity systems. Despite this, the Turkish authorities refused to adopt flexible exchange rate regime and this led to volatility in the nominal exchange rate system in the country economy. The real GNP as well as GDP of the country later dropped from nine point four percent to seven point four percent especially at the end of 2001.
There are various factors and elements that promoted the late 2001 financial crisis in Turkey including huge exchange rate depreciation systems, low capital flows as well as high account deficits and high interest rates. The Turkish Lira depreciated during this period by around sixty two percent and this led to low and poor economic development of the country.
A number of empirical and theoretical analyses of data indicate that the inflation and exchange rate mostly depends on the trade policies that are adopted by the government in the region. In order to achieve high and stable economic growth and development, exchange rates should be based on fiscal policy procedures especially through consideration of relevant measures. Monetary policies should also be made to direct link with the fiscal policy measures in order to reduce problems and challenges involving exchange rates. Trade liberalization policies, provision of foreign direct investments and promotion of exports are some of the major procedures and activities of promoting stable exchange rates and economic development in the country. This is because, these elements mostly boosts and provides foreign currency in the country leading to stable and proper inflow of international capital in the society. The exchange rate should be flexible in order to reduce uncertainty systems associated with devaluations of the domestic currency. Flexible exchange rate also reduce inflation rate leading to economic development of the country. Foreign exchange policies and export promotion procedures should be design by the government in order to attract foreign investment systems in the country. However, several research studies indicate that export products and services prices are usually determined and controlled by the international market systems. Political stability as well as macro-economic stability of the country is also very imperative towards the provision of proper development and growth of the country.
Policy makers should usually aim at avoiding inflation systems in the economy in order to provide stable exchange rates as well as to control inflationary pressure in the economy. The government should also promote a more secure and professional banking sector in order to reduce financial crisis and problems in the country. This will also promote efficient and effective use of the country limited financial resources thus leading to stable economic growth of the economy.
In late 2006, the Central Bank of Turkey (CBT) adopted inflation targeting policy in order to reduce high inflation rates in the country. This has brought high financial reforms and transparency systems towards various monetary policies in the country.
In conclusion, it is evident from this paper that there is a direct relationship among exchange rates, inflation and economic growth of a country. This is because in most cases, effective and stable exchange rate in the economy results in low inflation thus leading to economic growth of the country economy. In Turkey, the country has experience a number of financial challenges due to its weak exchange rate policy and currency systems. However, the adoption of flexible exchange rate in the late 2006 has improved economic growth of the country. From this paper it is also clear that long term relationships exists between real exchange rates, inflation and economic growth of the country. This is witnessed from a number of evidences in Turkey economic periods especially from early 1983 to late 2013. Some of the variables that indicate stable development and proper use of real exchange rates in Turkey include variance decomposition as well as other impulse response system.
Devaluation policies, liberalization factors as well as international trade policies form some of the factors that mostly determines the inflation rates and economic growth of a country. Poor exchange rate policies usually scare away investors in the country due to their influence on inflation rates. In that sense, global countries should adopt proper and stable exchange rates in order to promote their global trading systems and domestic economic growth. Free trade and trade tariff policies should be established especially towards the promotion of low inflation and economic development of the country. The government should also establish price control policies in order to reduce devaluation systems in the economy. The adoption of nominal exchange rates cans results to capital flow problems in the country. In that sense, government agencies should provide and implement global trade policies including free market systems in order to boost investor’s confidence in the country. This will improve economic growth and reduce inflation rates.
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