Policy implication: Capital inflows and macroeconomic indicators

Capital inflows are important factor to ease the country’s financial constraint. However, it is commonly perceived that the types of capital flows are essentially the same. This paper provides empirical evidences that different components of capital inflows have different effects on economic performance. This study utilizes data from the Turkish economy. The Turkish economy has been experiencing a current account deficit for a long time. The deterioration in the current account balance, coupled with the increasing share of short-term capital inflows to finance this deficit, causes the Turkish economy to become more vulnerable to sudden global financial changes (Akçelik et. al., 2013). According to study by Çimenoğlu and Yentürk (2005), one of the major reasons the Turkish economy is more vulnerable to crisis is the distribution of private investments in favor of nontradable rather than tradable sectors during surges in capital inflows. Capital inflows are important factors affecting macroeconomic performance, such as the real exchange rate, interest rates, output, and price level. However, the components of capital inflows are also important. Capital inflows in the form of portfolio investment liabilities, foreign direct investment, and other investment liabilities may affect these macroeconomic variables differently. Therefore, the appropriate policy responses to capital flows depends on the composition of the inflows. The main focus of this study is to analyze the behavior of key macroeconomic variables in response to the different components of capital inflow shocks for Turkey using monthly data from 2000:1 to 2012:12 by utilizing a Vector Autoregression (VAR) model. After the capital account liberalization in the early 1990s, Turkey attracted remarkable amounts of foreign capital inflows, in the form of portfolio investment, FDI, and other investments.  Capital inflows affect the wide range of key macroeconomics variables, such as the real exchange rate, the interest rate, output, and the price level. This study examines the effects of capital inflows and its components on the key macroeconomic variables for Turkey using monthly data from 2000:1 to 2012:12 by utilizing a VAR model