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1. Introduction
At the end of the 1970s when high inflation and unemployment were experienced together, the monetary policy that was developed for looking into solutions to the economic problems had begun to draw attention as an inner time process that was constituted by mutually strategic movements of monetary authority and private agencies. The difference with this new approach was to investigate monetary policy according to game theory ([25] Lewis and Mizen, 2000). The main aim of monetary authority as a player is to try to optimize the social welfare function by taking into consideration reactions of the other decision units ([14] Fountas, 1994). While this aim is being realized, the most important problem faced is the possibility of showing a "time-inconsistent" behavior about the policy that monetary authority follows. In fact, this problem reflects inflationary bias of monetary policy ([15] Friedman, 2000).
Whether optimal monetary policies are time-consistent or not is an important subject. Time-inconsistency means, in the simplest terms, that policies that were optimal in the past may no longer be optimal. The aim of this study is to analyze inflation rate and unemployment rate series for time-inconsistency. The structure of the time-inconsistency problem and its economic reflections from Turkey will be shown.
This paper is organized as follows: We begin by reviewing literature. We then test the validity of the Barro-Gordon model's implications by using state-space form and a Kalman filter. In order to investigate the long-run effects of the time-inconsistency problem, we apply unit root and co-integration tests. For the short-run effects, we use Hodrick-Prescott filter. Finally, the results of this study suggest that the time-inconsistency problem for Turkey can be valid in the short-run, but sufficient proof cannot be found to support the Barro-Gordon model's implications for the long-run.
2. Literature overview
The problem of time-inconsistency was first introduced by [24] Kydland and Prescott (1977) and [3], [4] Barro and Gordon (1983a, b). Kydland and Prescott give examples of how the time-inconsistency problem accrues in the macroeconomic relationship of inflation and unemployment. In the works of these two economists, the discretionary policy and the rule-based policy are compared. According to their results, if policy determination power is given to monetary authority in a discretionary manner, then the time-inconsistency problem of...