Erdogan reasons from a price change

[I wrote this a few weeks ago, and then decided not to post it.  After today’s news I changed my mind.]

Turkish President Erdogan claims that the way to lower inflation is to have the central bank hold down interest rates.  How’s that theory working out?

Turkey’s central bank sharply lifted its annual inflation forecast on Tuesday to 13.4 per cent just a week after keeping interest rates on hold as it grapples with a weakening currency.

The move to raise the outlook from a previous forecast of 8.4 per cent in April comes amid concerns by investors about the independence of the central bank, which has come under pressure from Recep Tayyip Erdogan, the Turkish president, who is a self-declared “enemy” of high rates.

Murat Cetinkaya, the central bank governor, pushed back against claims that political interference is limiting his ability to tackle soaring inflation. Consumer price inflation hit 15.4 per cent in June — a figure three times higher the official 5 per cent target.

NeoFisherians correctly point out that a monetary policy that produces a sustained period of low inflation will be associated with low nominal interest rates.  But cutting the central bank policy rate does not cause inflation to fall, just the opposite.

As an analogy, ownership of a Ferrari is strongly correlated with being wealthy.  However purchasing a Ferrari does not cause one to be wealthier, just the opposite.

PS.  In fairness, the Turkish central bank did recently increase rates sharply.  But it was too late; years of holding rates at 8% let the inflation genie out of the bottle.  Now it’s playing catchup.

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9 Responses to “Erdogan reasons from a price change”

  1. Gravatar of Tom Davies Tom Davies
    10. August 2018 at 21:45

    Which way does the inflation and exchange rate causality run? It seems to me that a falling exchange rate will increase inflation as prices of imports rise, but then again, inflation will obviously cause the currency to depreciate, in the absence of higher real interest rates.

  2. Gravatar of Ege Erdil Ege Erdil
    11. August 2018 at 00:13

    The Turkish central bank’s interest rate targeting system is a little complicated – they did not hold rates at %8 until they hiked all the way to %18. This is the one-week repo rate of the central bank, which was not their primary policy instrument for some period of time, instead they did central bank lending through something they call the “late liquidity window”. This rate was above %12 before the central bank decided in May this year to change back to using one-week repos as their primary tool for intervention in the interbank lending market.

    Other than that, if Erdogan really believed in neo-Fisherism he would implement a policy which would reduce long-term lira denominated bond yields and raise TRY/(foreign currency) futures contract prices, which he has not done. 2-year Turkish bond yields are at %25 right now, which means the market is already pricing in something like a 800 bps rate hike from the central bank over the next two years. Turkey is raising interest rates with an easy money policy, not with a tight money policy, and people who keep saying the central bank should raise rates are providing perfect cover for them to be able to do this.

    Turkey’s currency crisis can’t be solved with monetary policy alone anymore. CDS prices on Turkish government bonds are going up, the yield spread between US Treasuries and dollar denominated Turkish government bonds is widening, and Turkey has offered no plan whatsoever for how they are going to alleviate the concerns about a possible sovereign default. They have already inflated away a substantial chunk of the public debt. Under those conditions, monetary policy can do nothing unless there’s no doubt about the independence of the central bank.

  3. Gravatar of El roam El roam
    11. August 2018 at 05:49

    Such perception is correct indeed , but should be reserved :

    First , one should keep in mind : once interest rates are high , investors shift to currency based investments , shifting so , from stock markets to bonds for example . Now , for the economy typically , and for boosting growth , stock markets are very efficient and convenient way ( financially ) for firms , to go public and raise money and grow ( in terms of financial costs ) .

    Second , if the economy has basic capacity to grow , the central bank should encourage it , through low interest rates . Again , it is creating cheap money , and enhancing investments and growth ( low cost money for growing and innovating ) By that , one may fight inflation in fact . Why ?? because more production , more competition , would decrease inflation ( more competition , more supply ,and even better services ) .

    But does it fit Turkey ? surly one must doubt it . They don’t have enough : innovation capacity , International competitiveness , science and hi tech based economy and a like .


  4. Gravatar of El roam El roam
    11. August 2018 at 05:52

    Just correction :

    Should be : high tech of course , not : ” hi tech ”


  5. Gravatar of El roam El roam
    11. August 2018 at 06:30

    Just he who wants to read about relationship between interest rates and stock markets and growth , may read here some :


  6. Gravatar of ssumner ssumner
    11. August 2018 at 08:09

    Tom, Both are caused by monetary policy.

    Ege, Thanks for the info on interest rates. I certainly agree that the recent rate increases correlate with an expansionary monetary policy.

    And lack of central bank independence has obviously been a problem—Erdogan has been pressuring them to hold rates down.

    El Roam, You said:

    “Second , if the economy has basic capacity to grow , the central bank should encourage it , through low interest rates .”

    That’s a horrible idea–the market should set interest rates, not the government.

  7. Gravatar of El roam El roam
    11. August 2018 at 08:43

    ssumner :

    I have written the ” central bank ” ( should set interest rates ) and you have ” read in ” there ” government ” ?? From nowhere it seems ( the word ” government ” not mentioned even , at all ) .

    What seems to be the point then ??

    Read again ….


  8. Gravatar of ssumner ssumner
    11. August 2018 at 16:19

    El Roam, You are saying the Turkish government does not own the central bank?

    In any case, the central bank should not set interest rates.

  9. Gravatar of Christian List Christian List
    11. August 2018 at 23:32

    Erdogan, the flawless democrat, said that Allah is on their side and that’s why there’s nothing to worry about. It’s all a Jewish-Christian conspiracy.

    The theory that more economic prosperity leads to more freedom and democracy seems to be indestructible though. Take China as another example. Is falsifiability still a thing or are certain theories only poorly cloaked ideologies these days?

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