The Impact of Exchange Rate Volatility on The Inflation Rate: Evidence from Turkey

Exchange rate volatility can directly impact the general price level by causing changes in the costs of imported goods and services. In developing economies such as Turkey, sensitivity to exchange rate movements can be more pronounced due to a high dependence on imports and external financing sources. In this study, the relationship between variables was analyzed within the framework of the VAR model using the logarithmic values of monthly data spanning from January 2003 to May 2024. The cointegration test revealed that the variables are cointegrated in the long run and do not move independently of each other. The Granger causality test found a one-way causality at the 1% significance level, where M1 money supply affects both the exchange rate and inflation, and inflation affects the exchange rate. Based on the results obtained from the VAR models, variance decomposition analysis indicates that in Turkey, the primary driver of inflation is changes in the M1 money supply. Impulse response functions reveal that the effect of inflation on the exchange rate lasts for eight periods and ceases after the eighth period. In contrast, the response of inflation to M1 money supply persists for ten periods, exhibiting a slight increasing and decreasing trend after the seventh period. Therefore, in the formulation of economic policies, the effects of exchange rate and M1 money supply on inflation should be carefully analyzed and appropriate strategies should be determined.