The effectiveness of ultra-loose monetary policy in a high inflation economy: A time-varying causality analysis for Turkey

The highest rate of inflation was observed as countries faced increasing prices for food and energy, primarily due to supply disruptions caused by the COVID-19 pandemic and the war in Ukraine. In such challenging times, interest rate-based monetary policy remains an important issue for fighting inflation. From a policy perspective, central banks all over the globe tighten their monetary policy stance to cool inflation. Arguably, Turkey opted for an ultra-lose monetary policy via very low interest rates in response to high inflation. Drawing on the Turkish experience, we tackle the evolution of the Turkish central bank’s operations in the face of high inflation, providing further details on how ultra-loose monetary policy implementation can be extremely challenging in a highly inflationary economy. We extend the existing body of literature by employing the time-varying Granger causality model proposed by Shi et al. (J Time Ser Anal 39:966–987,2018; J Financ Econom 18:158–180, 2020). Using monthly data (2005:01 to 2022:01), we examine the links between interest rates, inflation, and exchange rates to detect possible changes across various time horizons. The major finding of this study explores the significant episodes of causality by detecting the origination date of causality starting from 2018 toward 2021. This finding confirms that August 2018 and its repercussions on the sharp currency depreciation and high Turkish inflation are pivotal moments to understand the nature of Turkey’s economic growth model and the impact of monetary policy in the ongoing economic crisis that hit Turkey harder. Our results reveal that a poorly managed country’s interest rate decisions can be disastrous for the exchange rate movements and inflation dynamics, whereas the conclusion is that there are limits to what central banks can do.