The Pakistan Development Review 40 : 3 (Autumn 2001) pp. 187—201 The Analysis of the Short-term Capital Movements by Using the VAR Model: The Case of Turkey ISMAІL ÇEVIŞ and CEM KADILAR This paper investigates the relations among short-term capital inflows, government deficit, interest rate differentials, real exchange rate and some accounts of the balance of payments in Turkey in 1990s by using the vector autoregression (VAR) technique. The dynamic behaviours of each variable due to random shocks given to short-term foreign liabilities are captured by impulse response functions, and the portion of variance in the prediction for each variable in the system that is attributable to its own innovations and to shocks to other variables in the system is analysed by variance decomposition method. It is found that the policy of high interest-low exchange rate (hot money) is the main reason for the short-term capital inflows in Turkey, and we propose some main controls on capital inflows to limit some of the macroeconomic repercussions of these inflows. 1. INTRODUCTION In recent years there have been many macroeconomic studies on the reasons and effects of capital flows such as Corbo and Hernandez (1993, 1996); Calvo, et al. (1993); Dooley and Kletzer (1994); Arias (1996) and Montiel and Reinhart (1999). The ratio of bank credits to total capital flows was 78 percent in the period between 1977 and 1982 [Altinkemer (1996)] when the 1982 debt crisis for developing countries occurred. After this debt crisis, total capital inflows to the developing countries decreased continuously till 1990. However, after 1990, there was a major difference in the amount and quality of capital flows in these countries as well as in transition economies, and during the period of 1990–1995 the capital flows increased 207 percent. These flows generally occurred in the name of short-term capital movements, portfolio investments, and foreign direct investment. Thus, during this period, these countries reduced the effects of foreign shocks by drawing in external resources from foreign direct investment, and portfolio investment, instead of bank credits. Ismail Çeviş is based at the Department of Economics, Hacettepe University, Beytepe, Ankara, Turkey. Cem Kadilar is based at the Department of Statistics, Hacettepe University, Beytepe, Ankara, Turkey. Authors’ Note: The authors would like to thank Resat Ceylan for helpful comments on the paper.