Professor Erdogan

Power is not omnipotence, although Central Asians seem to think that it is. Consider the claim of the president of Turkey, Recep Tayyip Erdogan, that high interest rates cause inflation.  Economics students in the Kazakhstani university where I teach think that the claim must be right, since otherwise a president would not make it.  In reality, it’s ridiculous.  High interest rates discourage people from taking out loans to finance an auto assembly plant or a Caribbean vacation.  Demand falls, so producers cut prices.  Bahama hotels, for example, offer Christmas specials.  Prices will fall throughout Bahama’s economy―the opposite of inflation.

Erdogan has it backwards. Expected inflation raises interest rates, because lenders want to be compensated for being paid off in weaker dollars than they lent out. Suppose that you lend me $1,000 for a year, when we all anticipate that prices will be 10% higher in 2020 than they are now.  The $1,000 that I will repay you next year would buy only as much as $900 would today.  To recover the lost purchasing power, you will charge me an interest rate of 10%.  Thus, in 2020, I will pay you $1,100, which will buy as much as $1,000 would today. In short, the interest rate fully reflects the expected rate of inflation.

In Turkey, the actual rate of inflation is already 19%―claiming the lion’s share of the market interest rate, 24%. Inflationary expectations are high partly because of Turkey’s long history of skyrocketing prices. Consumer inflation rates once surged over 100% in the past quarter of a century (Figure 1).

How to stoke risk

“Erdonomics” would be comical had the president not practiced what he screeched. Chronic inflation undermines demand for the Turkish currency since the lira is losing purchasing power. Consequently, the exchange rate of lira per dollar is rising, which boosts the lira prices of products and engenders uncertainty.

Sensibly, the head of Turkey’s central bank, Murat Cetinkaya, raised interest rates to revive demand for the lira. Higher interest rates make Turkish assets more attractive to hold; since you need lira to buy the assets, lira demand will increase, shoring up its exchange rate. Unfortunately, Erdogan insists that the fillip in interest rates will stoke inflation; so he fired Cetinkaya this month. The lira immediately weakened by 3%.

Yes, interest rates are already sky-high in Turkey, surpassing 24%. But that is partly because Erdogan’s do-it-yourself monetary policy has made the Turkish economy risky for financial investors, who demand compensation for that risk in the form of higher interest rates.

The Turkish turmoil might interest Central Asia, where politics dominate central banking as much as in Istanbul. In March, the governor of Kazakhstan’s central bank, Yerbolat Dossayev, said the bank’s base interest rate, 9.25%, kept inflation low.  A month later, in the runup to the June presidential election―where Nazarbayev protégé Kassym-Jomart Tokaev was running for his boss’s old job―the National Bank cut the rate to 9%, although it conceded that domestic demand and consumer loans were already rising.  “The current decision on the base rate will allow maintaining control over the prevailing inflationary background in order to keep inflation within the target range of 4-6% in 2019-2020 and helping to sustain the economic growth as much as possible,” stated the central bankers.

What they overlook is that actual inflation depends on expected inflation, which in turn depends on Bank policy. The bankers’ eagerness to cut interest rates raises the specter of future inflation. People will cope by raising their own prices today so that they can stash away enough money to afford high prices later for what they buy.  In June, the rate of consumer inflation rose to 5.4%, close to the top of the target range. One month does not a trend make, but you might well wonder whether inflation here may again become a self-fulfilling prophecy.

Already, in Turkey, everyone’s a prophet, except the president. ―Leon Taylor tayloralmaty@gmail.com    

Figure 1: Consumer inflation in Turkey since 1960. Data source: The World Bank.

References

National Bank of Kazakhstan.  Press release No. 11. The base rate reduced to 9.00%.  April 16, 2019.  nationalbank.kz

National Bank of Kazakhstan. Yerbolat Dossayev – The current base rate level contributes to reaching the inflation targets.  March 13, 2019.  nationalbank.kz

Good reading

Peter S. Goodman. Turkey’s long, painful economic crisis grinds on. The New York Times. July 8, 2019.