The Impact of the Financial Conditions on Validity of the Taylor Rule: Empirical Evidences on Turkey

The primary objective of the Central Bank of the Republic of Turkey (CBRT) has been determined to achieve and maintain price stability with the adoption of inflation targeting regime. However, after the 2008 Global financial crisis the reaction function of the CBRT has been modified with the inclusion of the achievement of financial stability to prevent the impact of fluctuations and unhealthy price formations in the financial markets. In this framework this article aims to investigate the impact of change in financial conditions on the interest rate setting behaviour of the Central Bank of Turkey. To this aim, an open economy Taylor rule model where the financial conditions index (FCI) is selected as the threshold variable is estimated based on threshold Generalized Method of Moments (threshold GMM) methodology covering the period from January 2006 to December 2016. The empirical results indicate the validity of the Taylor rule only during the period of financial expansion