DETERMINANTS OF NOMINAL EXCHANGE RATE

Purpose –Understanding the movements in the exchange rate will make it easier for households to make decisions by eliminating uncertainties. With the elimination of uncertainties, resources can be used in the most efficient way. As the level of awareness increases, a healthier communication will be established between the household and the policy authorities. In this study, the determinants of the nominal exchange rate in Turkey`s economy for a sample period of 2005M1-2018M10 were examined. Methodology – In order to establish the relationship between the variables correctly, a unit root test was implemented. According to the test results, it was decided that the appropriate methodology was Johansen Cointegration Analysis. Thus, the long-term causality relationship between variables was indicated. Findings – The first finding is that the most important determinant of USDTRY is the CPI difference between Turkey and USA. The Central Bank may use the policy interest rate as a policy tool to halt the continuous rise in the USDTRY. In addition, as the increase in industrial production is dependent on imported inputs, it leads to a depreciation in TRY. On the other hand, changes in oil prices have little impact on the USDTRY. Moreover, there is a mutual causality between inflation gap and USDTRY. Conclusion – In order to prevent the depreciation of the domestic currency, the Central Bank should first reduce inflation. The 10 unit inflation gap (CPI_tur-CPI_usa), causes a %40 rise in USDTRY. The Central Bank can use the interest rate as a policy tool to control this unexpected rise. Moreover, the inflation gap falls only if there is an increase in industrial production.