2.1.2. The CBRT and the New Monetary Policy Strategy

The economic environment that has emerged after the global crisis shows that central banks should attach importance to financial stability as well as price stability as summarized in Section 2.1.1. Therefore, the CBRT designed a new monetary policy strategy that highlights financial stability without prejudice to the price stability of the inflation targeting regime adopted in 2006.

Table 1 presents a comparison of the CBRT's former and new policy strategies with respect to their objectives and instruments used. The existing framework has been largely improved in terms of objectives and instruments compared to the standard inflation targeting regime implemented since 2006. The new regime preserves the primary objective of price stability, while risks to financial stability are monitored more closely while conducting the monetary policy. In other words, observing financial stability as an objective calls for the use of multiple instruments in monetary policy both in structural and cyclical terms. Accordingly, monetary policy instruments like the interest rate corridor, effective liquidity management, required reserves, and the ROM policy were effectively employed in 2012.

Interest Rate Corridor

The interest rate corridor has been one of the foremost monetary policy instruments that the CBRT has frequently employed to influence market rates and liquidity in the recent years. Fund-needing banks in the market can be provided with short term (in daily, weekly or monthly maturities) liquidity by the CBRT, while the banks with excess funds can lend funds at an overnight maturity. In technical terms, the interest rate corridor is the margin between the lending and borrowing rates of the CBRT. As required by the operational structure, market rates are formed within the interest rate corridor. Under the current structure, as the CBRT provides funding mainly through weekly repo transactions, the "policy rate" is set as the one-week repo funding rate. Both the policy rate and the interest rate corridor are revised in the monthly MPC Meetings and announced to the public.

In the traditional sense, the interest rate corridor is usually employed by central banks implementing inflation targeting to prevent market rates from significantly deviating from the policy rate. Accordingly, the interest rate corridor, which is defined as a symmetrical (generally constant) and narrow band around the policy rate, assumes an inactive role. On the other hand, the CBRT's current system considers the interest rate corridor as an active instrument: The CBRT can adjust the width of the interest rate corridor when necessary, and at the same time adjust the corridor around the policy rate in an asymmetrical way. Under this structure, the interest rate corridor not only facilitates a faster and more flexible reaction to the volatility in short term capital movements, but also can be used as an effective instrument against credit growth.

Reserve Options Mechanism

The CBRT has recently developed the Reserve Option Mechanism (ROM) that mainly aims at reducing the adverse impact of the excessive volatility in capital movements on the macro-financial stability. This instrument allows the banks to hold a certain portion of the Turkish lira (TL) required reserves in FX and gold. The extent to which this facility can be used is defined as the reserve option ratio (ROR). The coefficients showing the amount of FX or gold to be held per unit of TL reserve requirements are defined as the Reserve Option Coefficients (ROC).

The ROM was mainly designed as an "automatic stabilizer" (in a way that banks can internally adjust the utilization rates of reserve option against external shocks). As this concept enables each bank to make its own optimization given its own constraints, the ROM is considered to be more efficient in the economic sense compared to other instruments used in FX liquidity management. Moreover, parameters of the system can also be used as a cyclical instrument to adapt to the permanent changes in domestic and external environment when necessary. Facilities offered through the ROM also have a positive effect on the CBRT's foreign exchange and gold reserves.