Unconventional Monetary Policies and Foreign Exchange Swaps: the Case of Turkey

Abstract

To manage the risks from increased global liquidity after the 2008-2009 financial crisis, the Central Bank of Turkey (CBRT) heavily resorted to using the required reserve ratio, in addition to its conventional policy rate, as an active monetary policy tool. Additionally, it introduced new tools such as an asymmetric interest rate corridor and a reserve option mechanism. This study estimates a shadow interest rate to assess the CBRT's post-crisis monetary policy stance. This shadow rate coincides with the CBRT's weighted average funding rate (WAFC) until the end of 2016, indicating minimal impact from unconventional tools. However, from late 2016 to the end of 2017, the shadow rate is below the WAFC. We link this divergence to Turkish banks' increasing swap exchange transactions and the resulting liquidity inflows of Turkish lira from overseas markets. Our results indicate that the transmission mechanism of monetary policy could be improved with better coordination of conventional and unconventional tools, as some of these tools exhibited isolating effects. Additionally, monitoring and managing off-balance sheet transactions can enhance the effectiveness of monetary policy.