An Analysis of Inflation Expectations of the Turkish Private Manufacturing Industry

Abstract

The main purpose of this paper is to make a detailed analysis of the quantified expected inflation series obtained from the Business Tendency Survey conducted by the Central Bank of the Republic of Turkey. Different representations of simple expectation formation mechanisms that appeared in the literature are discussed in the context of Turkey. In selecting the most appropriate mechanism, instead of an ad hoc and an arbitrary methodology, nested hypotheses and the sequential testing procedure are applied. A general first order extrapolative mechanism is found as a result of this procedure. But, the selected mechanism is far from being satisfactory. Therefore, a new augmented model, in which one lag of inflation, exchange rate, private sector capacity utilization rate, stock evaluations of the last three months and average cost expectations of the next three months are employed as explanatory variables, is proposed. Finally, taking into account problems regarding the tests of rationality, efficiency and orthogonality tests are carried out. As a result of these tests, rationality assumption cannot be rejected very powerfully. However, this is not stemmed from the accuracy of the expectations, but from the structure of the economy that precludes accurate short-term forecasting.