Understanding Taylor Rule and Its Welfare Implications: Estimating a New Keynesian DSGE Model for Turkey

Abstract

In the recent years, Turkey went through a currency crisis as Turkish Lira depreciated rapidly. To understand Turkish economy better, we estimate a New Keynesian DSGE Model for Turkey, implementing Galí’s (2008) model. Next, the welfare implications of the model are analyzed. When the economic fluctuations are caused by a technology shock, the welfare loss increases as more importance is given to output stabilization. When the economic fluctuations are caused by a demand shock, the welfare loss decreases when an output stabilization stance is implemented. The results imply that under a technology or a demand shock, the welfare loss is minimized when monetary policy reacts very aggressively to changes in inflation but doesn’t react to changes in output.