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Currency substitution, policy rule and pass-through: evidence from Turkey

In this article we analyse empirically currency substitution and exchange rate pass-through in the Turkish Economy, where their ongoing presence could undermine the implementation of a successful monetary policy, especially in a flexible exchange rate regime. Even though a considerable time has passed after the implementation of a flexible exchange rate regime in Turkey, by using Vector Error Correction model for the period from 1987 to 2004, we find that the currency substitution and exchange rate pass-through still have importance in the Turkish Economy and the monetary policy stance has been considerably strong, possibly, as a response of ongoing presence of them. If this is the case, to avoid the undesired consequences of this strong monetary policy, Turkey should consider some policy measures to reduce the degree of pass-through and currency substitution.