Journal of Applied Economics and Business Research JAEBR, 13(2):86-109(2023) Copyright © 2023 JAEBR ISSN 1927-033X The Effects of Monetary Policy on the Economy in Türkiye: FAVAR Approach * Fulya Gezer 1 Ankara Haci Bayram Veli University,Türkiye Seher Nur Sulku 2 Ankara Haci Bayram Veli University,Türkiye Abstract We investigate the effects of monetary policy on key macroeconomic variables in Türkiye over the [2005, 2019] period. We employ the Factor Augmented Vector Autoregressive (FAVAR) model involving 125 macroeconomic variables, including economic activity, money supply, interest rate, exchange rate, price level, and their sub-items. We aim to provide a comprehensive and coherent picture of the effect of monetary policy on the Turkish economy compared to the standard VARs. We examine the effects of two shocks on Turkish economy: 'interbank interest rate', a proxy variable for the policy rate of the Central Bank of the Republic of Türkiye, and ‘spread’, an alternative monetary policy measure which is the difference between interbank interest rate and treasury auction rate. Both of these shocks have significant effects on key macroeconomic variables in Türkiye. A positive interbank interest rate shock decreases the industrial production index, money supply, and real effective exchange rate, while increasing the short- and long-term deposit interest rates, which are largely consistent with conventional wisdom. However, following the monetary tightening, consumer inflation increases, contrary to economic theory. Thus, the price puzzle is observed. But a positive spread shock decreases the consumer inflation and the price puzzle disappears. Keywords: Monetary policy, developing countries, Türkiye, price puzzle, FAVAR JEL Codes Classification: C01, C38, C87, E32, E52 Copyright © 2023 JAEBR 1. Introduction Developing countries that are more integrated with global economic and financial markets with respect to trade and financial linkages, such as Türkiye, Brazil, Mexico, Chile, Sri Lanka, Egypt, Pakistan and Iran, are exposed to significant spillovers from the rest of the world. Their economies' vulnerability to both external and internal shocks causes a significant effect on domestic macroeconomic and financial variables (Kamin and Rogers, 1999; Arora and Censola, 2000; Le Fort and Parrado, 2006; Catao et al., 2008; Alp and Elekdag, 2011; Perera and Wickramanayake, 2013; Munir and Quayyum, 2013; Tabaghi, 2013; Kilinc and Tunc, 2014; Lemaire, 2019; Banaian et al., 2020). Therefore, investigating the effects of monetary policy * This paper was produced from Fulya Gezer's PhD thesis titled 'Economic fluctuations in Turkey: FAVAR approach', submitted to the Department of Econometrics, Ankara Haci Bayram Veli University in 2022. 1 Correspondence to Fulya Gezer (ORCID: 0000-0002-4885-1213), E-mail to fulya.gezer@hbv.edu.tr 2 Seher Nur Sulku (ORCID: 0000-0002-4938-4565)