What is Monetary Tightening Policy?

What is Monetary Policy? Which Institution Implements Monetary Policies?

Monetary policy is defined as the practices carried out to balance the money supply and price levels in the economy. Nowadays, monetary policies are especially important in keeping the inflation level under control.

While many different variables are taken into account in determining monetary policy, short-term targets are generally determined by interest rates. So, you see, changes in interest rates have a strong impact on the markets.

In our country, the Central Bank of the Republic of Turkey has the authority and responsibility to determine the monetary policy, which has a direct relationship with asset prices, economic activity level, general prices, exchange rates and many other economic parameters.

Monetary policies, carried out with special strategies determined by a body called the Monetary Policy Board (MPC), are regulated 8 times a year and in accordance with a predetermined schedule.

So, what exactly does the policy of monetary tightening, one of the strategies likely to emerge as a result of these meetings, mean?

What is Monetary Tightening Policy? How to Apply?

Monetary tightening policy is defined as the monetary policy implemented to reduce the high money supply level in the market. The tight monetary policy implemented by the Central Bank of the Republic of Turkey (CBRT) is generally used to reduce high inflation levels.

The essence of the monetary tightening policy system lies in the principle of limiting consumer demands and increasing the tendency to save. Thus, inflation that may arise from the demand level being higher than the supply level is prevented.

Monetary tightening policy generally requires the implementation of a series of measures such as increasing interest rates. Therefore, this situation may cause people to be indecisive when it comes to choosing different investment instruments by prioritizing savings. In economic systems where interest rates are high, potential investors may choose to postpone their investments.

What are the Goals of the Monetary Tightening Policy?

Although the monetary tightening policy has many different objectives, it is essentially implemented with the aim of controlling high inflation.

Thus, with the decrease in money supply and inflation, changes are observed in many different economic parameters. The objectives of the monetary tightening policy are briefly listed as follows:

• It is implemented with the aim of controlling inflation and ensuring price stability. Low and stable levels of inflation allow consumers and businesses to better predict future prices and make economic decisions more consistently.
• Restrictive monetary policy is implemented with the aim of preserving the value of the local currency. It aims to ensure the stability of exchange rates by preserving the value of the currency.
• The aim of the monetary tightening policy is to prevent excessive fluctuations in the economy. This policy can also be used to ensure that economic activities progress at a sustainable pace and on a solid basis.
• Monetary tightening can also be applied to ensure financial stability and reduce financial risks such as disproportionate credit expansion or asset bubbles.
• High inflation levels increase the cost of imports. Therefore, it may cause the external balance to be disrupted. Thanks to the monetary tightening policy, import demand is reduced and the foreign trade balance can be corrected.

What are the tools of the monetary tightening policy?

• Turkish Central Bank interest rates
• Open market operations
• Required reserve ratios
• Discount rates
• Foreign exchange transactions

What Precautions Can Be Taken Within the Scope of the Monetary Tightening Policy?

Monetary tightening policy measures aim to reduce the money supply in the economy and include a series of steps used to control inflation. Now that we have clarified what monetary tightening means, let’s take a quick look at the measures that can be taken to achieve this goal:

• Increasing interest rates:The central bank can increase the cost of borrowing by increasing short-term interest rates. In this way, it can reduce consumer spending and investments by increasing credit costs.
• Increasing the reserve requirement:The central bank may impose a requirement on banks to increase the minimum amount of reserves they must hold. Thus, banks can use the available liquidity less and thus reduce the credit supply.
• Asset sales through open market operations:The central bank can reduce the money supply by buying and selling treasury bills, bonds and stocks. With this method, the amount of money circulating in the market is reduced and interest rates can be increased.
• Intervention in the foreign exchange market:Direct intervention in the foreign exchange market can be made in order to increase the value of the local currency. In this way, the cost of imports is increased and domestic demand may be reduced.
• Macroprudential measures:The level of economic activity can be reduced by changing and tightening banks’ lending standards or by making regulations to reduce financial risks.
• Credit restrictions on banks and financial institutions:The central bank can directly regulate and impose limits on the lending capacity of banks and financial institutions.
• Special taxes on luxury consumer goods:Consumption can be reduced by imposing additional taxes on luxury consumer goods.

These measures are used to control the inflation level, ensure financial stability and regulate economic balances. One or more of these measures can be applied simultaneously.

However, it is important to take into account the risk that the monetary tightening policy will affect economic growth and to continue it carefully.

How Does Tightening Policy Affect Stock Prices?

Theoretical studies show that monetary policies have a negative and significant effect on stock prices in the short term. However, it is not possible to determine exactly through which channels this effect occurs.

The existence of many factors affecting stock prices and the interaction of these factors with monetary policy makes it difficult to clearly determine this relationship.

Rising interest rates during periods of monetary tightening increases the cost of borrowing. Therefore, companies’ profitability expectations may decrease and stock prices may decrease.

The impact of monetary policy on stock prices is associated with changes in interest rates as well as in the financial structure of companies. Due to monetary tightening policies, the lending capacity of banks may decrease. Thus, companies may have to use more equity capital. Changes in interest rates directly affect companies’ investment decisions and cash flows.

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