**1. Introduction**

The phenomenon of high inflation arising from the 1970s oil crisis and the collapse of Bretton Woods's system has brought price stability to the base of the monetary policy. While inflation, growth, exchange rate and interest rate should be in harmony in order to prevent financial-based crises, to eliminate income distribution imbalances and to increase prosperity, the implicit relationship between monetary and fiscal policies should not be ignored in developing countries that are subject to the inflation-targeting regime.

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Inflation uncertainty has an effect not only on monetary and fiscal policy variables but also on economic growth and indirectly on the real sector by affecting both real net revenues and price system efficiency in resource allocation. In emerging markets economies, interest rate and exchange rate, which are indicative variables, have a decisive influence on the real and nominal sectors for sustainable development and a stable economy. Changes in interest rates and exchange rates affect domestic and foreign investment decisions and consumer behaviors. High interest rates increase risk perception as they cause inflationary expectations. Moreover, volatility that may be experienced at interest rates creates exchange rate uncertainties. Thus, the exchange rate instability affects the real sector and it causes economic instability. In open economies, exchange rates are controlled through interest rates (usually short term) when it is necessary.

Tax revenues follow a fluctuating structure in emerging economies where the economies are not fully managed due to the influence of political structure. Tax revenues can be seen as a means of development by the direct or indirect effect of resource allocation in developing countries. Macroeconomic balances are realized at a lower cost in the shorter term as the tax revenues are directed toward the financing of the growth. The longer the average collection period of taxes, the greater the magnitude of the corrosive effect on tax revenues is related with inflation. Depending on inflation, inflation rate increases by increased risk premiums due to economic uncertainty and instability. Funds used in the financing of the growth by excluding investments shift to nontaxable areas. The economic contraction due to the diminishing of investments reduces the taxable potential.

Tax revenues create economic conditions for stability and growth by reducing the debt burden of the public sector and alleviate the pressure on interest and inflation. Therefore, public expenditures also have an effect on the relation between inflation and tax revenues. The change in public expenditure activates the multiplier mechanism and causes a change in income, consumption and tax revenues. The high public debt burden may affect inflation expectations and can constitute difficulties to meet the inflation target. Government revenues increase as total savings, and taxable potential increases in moderate inflation periods.

Imbalances between government revenues/expenditures, elimination of existing debts by borrowing, problems in banking system, deficiencies in risk management processes, monetary and fiscal policy approaches which are far from rationality and the environment where short-term capital movements for speculative purposes are widespread due to increasing globalization and economic liberalization movements make an inflation spiral in emerging economies as well as in Turkey.

The effectiveness of inflexible monetary policies has disappeared because of the fluctuations in the variables used as main or intermediate target. High inflation, floating growth rates, high public deficits and a dollarized economy emerged between 1989 and 2001 in Turkey because of not only the short-term capital movements started to be effective in the economic structure but also unrealizable financial and structural reforms. In this period, monetary policy approaches that target interest rate, foreign currency exchange rate and monetary aggregates had been used in the economic system. Interest-exchange rate targeting has been abandoned because of the changes in shocks in the economic structure and high-floating inflationary periods that make interest targeting difficult. The increase in capital movements and the decrease in flexibility against global shocks made the use of the exchange rate ineffective. Monetary aggregates could not be applied as intermediate targets owing to the structural changes and financial liberalization, and programs had resulted in disappearance of stability in the currency speed of money, the emergence of new financial instruments and the destabilization of the money demand caused by fast-growing financial sector. The exchange rate policy has been changed to the floating exchange rate regime because of the anticipation that it could be effective in closing the current account deficit and the monetary policy gained independence. Inflation had been adversely affected because the foreign exchange rate, which is sensitive to external shocks, exhibited a volatile structure and the perception that the interventions made on the interest rate were considered as interventions to the exchange rates.

Inflation uncertainty has an effect not only on monetary and fiscal policy variables but also on economic growth and indirectly on the real sector by affecting both real net revenues and price system efficiency in resource allocation. In emerging markets economies, interest rate and exchange rate, which are indicative variables, have a decisive influence on the real and nominal sectors for sustainable development and a stable economy. Changes in interest rates and exchange rates affect domestic and foreign investment decisions and consumer behaviors. High interest rates increase risk perception as they cause inflationary expectations. Moreover, volatility that may be experienced at interest rates creates exchange rate uncertainties. Thus, the exchange rate instability affects the real sector and it causes economic instability. In open economies, exchange rates

Tax revenues follow a fluctuating structure in emerging economies where the economies are not fully managed due to the influence of political structure. Tax revenues can be seen as a means of development by the direct or indirect effect of resource allocation in developing countries. Macroeconomic balances are realized at a lower cost in the shorter term as the tax revenues are directed toward the financing of the growth. The longer the average collection period of taxes, the greater the magnitude of the corrosive effect on tax revenues is related with inflation. Depending on inflation, inflation rate increases by increased risk premiums due to economic uncertainty and instability. Funds used in the financing of the growth by excluding investments shift to nontaxable areas. The economic contraction due to the dimin-

Tax revenues create economic conditions for stability and growth by reducing the debt burden of the public sector and alleviate the pressure on interest and inflation. Therefore, public expenditures also have an effect on the relation between inflation and tax revenues. The change in public expenditure activates the multiplier mechanism and causes a change in income, consumption and tax revenues. The high public debt burden may affect inflation expectations and can constitute difficulties to meet the inflation target. Government revenues increase as total savings, and taxable potential increases in moderate inflation periods.

Imbalances between government revenues/expenditures, elimination of existing debts by borrowing, problems in banking system, deficiencies in risk management processes, monetary and fiscal policy approaches which are far from rationality and the environment where short-term capital movements for speculative purposes are widespread due to increasing globalization and economic liberalization movements make an inflation spiral in emerging

The effectiveness of inflexible monetary policies has disappeared because of the fluctuations in the variables used as main or intermediate target. High inflation, floating growth rates, high public deficits and a dollarized economy emerged between 1989 and 2001 in Turkey because of not only the short-term capital movements started to be effective in the economic structure but also unrealizable financial and structural reforms. In this period, monetary policy approaches that target interest rate, foreign currency exchange rate and monetary aggregates had been used in the economic system. Interest-exchange rate targeting has been abandoned because of the changes in shocks in the economic structure and high-floating inflationary periods that make interest targeting difficult. The increase in capital movements and the decrease

are controlled through interest rates (usually short term) when it is necessary.

ishing of investments reduces the taxable potential.

236 Financial Management from an Emerging Market Perspective

economies as well as in Turkey.

In order to achieve price stability in the Turkish economic structure, it has been decided to implement the inflation-targeting regime, a monetary policy approach that targets directly inflation without using any intermediate targets. In Turkey, due to domestic debt stock and high interest rates, the transition to the inflation-targeting regime could not be possible immediately. With the transition to the inflation-targeting regime, which had been implemented in 2003, inflation and the level of dollarization had started to decrease. With the transition to the inflation-targeting regime in 2006, inflation reached single digits and the aim changed as price stabilization. Due to the difficulty of keeping inflation under control in emerging economies and the delayed/prolonged effects of the monetary-fiscal policy instruments on inflation, the long-term internal and external shocks experienced in Turkey between 2002 and 2009 created disruptions in the operation of the regime.

Since the relationship between uncertainty and macroeconomic variables is sensitive to various factors such as sampling period, model classification and uncertainty identifications, different results have been determined in studies among inflation, output growth, interest rate and inflation uncertainty. Almost none of the studies have been found within the scope of the developed economies or the developing economies on the interactions of inflation uncertainty with real effective exchange rate, tax revenues and government expenditures.

Cukierman et al., Azariadis et al., Friedman and Deveraux [1–4] argue that there is a positive relationship between inflation and inflation uncertainty. Baillie et al. [5] conclude that the Cukierman-Meltzer hypothesis is valid only in high inflationary countries. Pourgerami et al., Ungar et al. and Grier et al. [6–8] argue that there is an inverse relationship between inflation uncertainty and inflation rate. Bhar et al. [9] have concluded that inflation uncertainty has diminished inflation after inflation targeting. Holland [10] argues that higher inflation uncertainty may be associated with lower average inflation. While Dotsey and Sarte [15] find that inflation uncertainty has a positive effect on growth, Friedman, Pindyck, Beaudry et al.,Tommasi and Fountas et al. [1, 11–14] determine an inverse relationship between inflation uncertainty and output growth. Bhar et al. [9] point out that inflation uncertainty reduces the growth rate after inflation targeting. Chan [16] suggests that uncertainty reduces output growth by reducing consumption and investment spending with interest rates when there is a positive relationship between inflation uncertainty and interest rates. Berument et al. [17] show that inflation uncertainty increases 3-month deposit interest. Omay et al. [18] show that the effect of the inflation risk on the interest rates is regime dependent.

In case of uncertainty, determining the interaction of real and nominal economic variables with inflation uncertainty is important in shaping economic policies of countries experiencing problems with inflation. In this study, it is investigated whether the inflation-targeting regime causes a structural change in the economic system exposed to high- and low-inflation periods. It is aimed to contribute to the literature by focusing on the effect of inflation uncertainty on inflation, output growth and selected monetary-fiscal policy instruments under the inflation-targeting regime. Within the scope of the study, inflation-targeting period was accepted between 2003 and 2015 and preinflation-targeting period was between 1987 and 2003. The effect of inflation uncertainty on real and nominal economic indicators is examined using multivariate generalized autoregressive conditional heteroscedasticity (MGARCH) model. Because volatility is a quantitative measure of the risk that individual investors and financial institutions face, it is one of the noteworthy features of financial data. Because of the fact that financial changes move together over time, the ability to envision and forecast the dependency of second-degree moments of return is important in financial econometrics. The multivariate GARCH models, which are developed based on the fact that financial asset volatilities move together over time, provide efficiency gains. In order to handle all the possible interactions in a system equation, solutions are obtained by using full-information maximum-likelihood method.

In this way, with the help of an equations system that is stated in a multivariate structure, all the possible interactions are tackled together and solutions are obtained based on complete information. In addition, with the help of a slope dummy variable, which was defined to differentiate the periods before and after 2003, the effects of inflation and output uncertainty have been assessed for both high and low inflation periods. The study first takes a general look at the related literature about inflation uncertainty. It then moves on to defining the model and obtaining empirical findings which were established over the model. The study concludes with an assessment section in which the empirical findings obtained are evaluated.
