Economic policy is undergoing a kind of revolution today, with many ideas about growth, inflation, and monetary policy that were once unorthodox and are now getting credit. But Turkey’s faith that can tame inflation by lowering rates of interest is surely not among them.
Late on Friday, Turkish President Recep Tayyip Erdoğan fired the governor of the national central bank, Naci Ağbal, and replaced him with Şahap Kavcıoğlu, a political ally. The Turkish lira fell 8% against the US dollar on Monday, and could suffer prolonged instability. Turkey has had three different central bank governors in less than two years. It seems that Kavcıoğlu is going to adhere to government guidelinesNot like Ağbal, who was more technocratic and whose tenure once again attracted capital to the lira.
The importance of the independence of monetary policy, which has proven to be ineffective in combating weak inflation and growth, it is often exaggerated. Investors are rediscovering the benefits of coordination between governments and central banks, even in developing countries. Turkey’s problem is not so much that the central bank is controlled by Erdoğan, but rather that Erdoğan appears to misuse that control.
Agencies
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Contrary to the majority opinion that higher interest rates help to control inflation, the Turkish president believes that they boost it, because raising the price of money increases the costs of borrowing for companies. That is surely the reason why he has fired Ağbal, who returned to tighten monetary policy last week. Kavcıoğlu’s articles in the local press indicate that he agrees with Erdoğan and that he may lower rates again. He has also written that the lira has remained too strong and has undermined Turkey’s competitiveness.
This is an illusion. The theoretical link between interest rates and inflation may not be strong in Western countries, but they do not suffer periodic currency crises. In emerging markets, most inflation comes from sharp falls in the exchange rate, which increases import costs, so the central bank’s main focus should be the currency.
To strengthen it, raising rates is a key tool. Less orthodox policies as floating exchange rates and capital controls, which are also being revalued by economists, can help, but only if they are applied consistently. Turkey has used them chaotically to curb panic, rather than as part of a reliable long-term monetary strategy.
Any backing from its dollar reserves won’t last long: They were drying at a rate of $ 4 billion on average a month before the Turkish central bank raised rates last year. Turkish foreign exchange reserves amount to $ 18 billion, although in reality it has them in the form of loans. In reality, Turkey’s foreign currency reserves are negative $ 20 billion, not including swaps with banks and other governments.
In inflation-adjusted terms, the lira has been falling for a decade and is currently around its lowest value ever recorded. This complicates the thesis of that the currency is overvalued and it suggests that persistent trade deficits have more to do with a structural dependence on foreign raw materials.
Central banks are increasingly adapting to the importance of provide ‘forward guidance’ (future predictability) consistent for investors. Erdoğan’s latest move offers little hope that his way of applying monetary heterodoxy could succeed.
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Economic policy is undergoing a kind of revolution today, with many ideas about growth, inflation, and monetary policy that were once unorthodox and are now getting credit. But Turkey’s faith that can tame inflation by lowering rates of interest is surely not among them.
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