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The target of monetary policy is generally set as to create an environment of manageable employment and affordable long-term interest rates. However, priorities of central banks may differ depending on economic and financial circumstances of individual countries. Modern approaches to monetary policy transmission can be grouped under two headings, Money View and Credit View. The money view concentrates on interest rates to explain the effects of monetary policy on aggregate spending by creating an interest rate channel. The credit channel transmission approach focuses on the supply of credits by banks following a monetary policy shift in interest rates. In 2010, the Central Bank of Turkey (CBT) developed an interest rate corridor shaped by one-week and overnight repo lending to the financial banks to absorb excessive volatility caused by short-term capital inflows. Under this framework, the CBT implements its monetary policy in two ways; firstly it can alter the interest rates of weekly repo as well as O/N lending rate. Secondly, it can configure the funding structure it provides to the financial intermediaries. In such a framework, the interest rate transmission mechanism has been operated by two benchmark interest rates, one of which is the weighted average of the cost of funds provided by the CBT and the other is the interest rate in Borsa Istanbul (BIST) money market transactions at an overnight maturity. There is a strong co-movement between the interest rates and they are affected by the movements in the CBT lending rate in both directions. Interest rates applied to deposits and loans by banks are affected by the policy rate (CBT Average Funding Rate) and the market rate (BIST O/N Repo Rate)

Perspectives on Monetary Policy and Cost of Capital: Evidence from Turkey