Before The Fall Was The Turkish Lira Overvalued?

This paper examines validity of purchasing power parity to evaluate whether the Turkish Lira was overvalued on the eve of 2001 crises. Univariate and multivariate time series techniques are used to test whether the real exchange rate is mean reverting. Half-life of deviation from purchasing power parity for various definitions is derived. The Johansen cointegration test procedure is applied to bilateral exchange rates using CPI and WPI price indexes. Finally, different measures of misalignments are calculated. Evidence provided that calculated half lives are, in general, short compared to low inflation countries. Further, data supports the long-run relationships among exchange rates, domestic and foreign prices. Calculated misalignments give mixed results on bilateral exchange rates based on CPI and WPI. While WPI based bilateral real exchange rate gives under valuation, the CPI based bilateral real exchange rate and trade weighted real exchange rates based on WPI reveals that TL was overvalued before the eve of 2001 crises.