Canada’s central bank has done it nine times, the US Federal Reserve (Fed) ten times, and the European Central Bank eight. Monetary authorities are raising interest rates to fight inflation in most countries except one: Turkey, which has done the opposite.
Since the beginning of 2021, when most central bankers went to war on inflation, the Turkish central bank’s key rate has fallen nine times.
It’s that President Recep Tayyip Erdoğan, who has ruled the country for 20 years and who has just been re-elected, is convinced that rising interest rates are fueling inflation rather than reducing it. This is the flip side of classic economic theory that higher interest rates reduce consumer and business demand for goods and services, slow the economy, and curb rising prices.
The Erdoğan recipe seemed to work well in the first years of his reign, which began in 2003. The country’s economy took off thanks to deregulation and privatizations which attracted foreign investors. Along with the high rates of gross domestic product (GDP) growth came inflation, exacerbated by the pandemic, which the Turkish government refused to combat with conventional means of monetary policy.
It is also the reverse of traditional economic theory, which holds that an effective monetary policy must be conducted independently of political power.
The Turkish government’s contrarian monetary policy has fueled inflation, the official rate of which peaked at almost 100% in 2022 and which, according to the most recent figures, is still at 40%.
To relieve a population strangled by hyperinflation, the government raised the minimum wage several times and tried somehow to support its plummeting currency by emptying the country’s foreign currency reserves.
The Turkish lira has lost 80% of its value for five years and the state coffers are empty, but the Erdoğan recipe seems to have succeeded in getting him re-elected on May 23.
After the election, the country’s currency hit an all-time low against the US dollar, which seems to indicate that the government, once it achieved the goal of being re-elected, stopped artificially supporting the cash.
President Erdoğan begins a new mandate in a country on the brink of financial abyss. His first decisions surprised everyone. He appointed a Wall Street banker to head the Central Bank of Turkey. The first woman to hold this position, Hafize Gaye Erkan graduated from Princeton and had a career at Goldman Sachs and the First Republic Bank of San Francisco, which has just been acquired by JPMorgan Chase.
Another expert from Wall Street orthodoxy, Mehmet Şimşek, a former economist at Merrill Lynch, has been named economy minister.
Clearly, the duo’s mission is to save the Turkish economy from total wreckage. Will he succeed? It will take time to restore the credibility of monetary policy and, above all, independence from the government to be able to make difficult decisions.
The first decision of the new governor of the Turkish central bank on interest rates is expected on June 22. The market expects a jump in the key rate, which could double in one fell swoop, according to the polls. For an electric shock, it would be quite a blow for the economy.
What to ponder while here, we wonder if the Bank of Canada is doing too much or not enough to reduce the rise in prices.