Turkey, inflation, and the sages of The New York Times

Turkey’s glacial response to the two earthquakes of February 6 has spotlighted its sputtering economy.  In October, well before the earthquakes, the rate of inflation was already 85%. Now shortages of housing and infrastructure will send prices soaring. About the President of Turkey, The New York Times writes:

“Adding fuel to the fire is Mr. [Recep Tayyip] Erdogan’s insistence on lowering interest rates in defiance of a broad economic consensus that inflation should be contained by raising them.

“Although that approach has helped stabilize the lira’s free fall — a dollar now buys nearly 19 lira, compared with 13.50 a year ago — it has come at a high price. Today, over two-thirds of households are struggling to pay for food and rent, and more than half of workers earn wages worth less than the equivalent of $300 a month because of the lira’s devaluation...”

Hmmm.  Despite The Times's claim, cutting interest rates certainly hasn’t steadied the lira. A fall in terms of dollars of 29% purchasing power in one year, even before adjusting for inflation, is no jest. The decline has occurred in part because lowering interest rates cuts the rate of return to investors of holding lira rather than dollars. So they become more likely than before to sell lira and buy dollars. This fall in demand for lira decreases the amount of a dollar that a lira can buy. In other words, Erdogan’s policy of holding down interest rates is exactly why the lira has devalued, boosting the prices paid by Turks.

The lira fell sharply from 14 lira per dollar to 18 last year from February to August, when it leveled off…not because the central bank kept cutting the interest rate but because it finally held it constant. For a while.

The Times continues:

“Mr. Erdogan has tried to offset the pain by increasing salaries for public-sector employees, raising the minimum wage twice last year and boosting fixed pension payments. But those measures have largely been gobbled up by inflation….”

Inflation rises in part because Erdogan raises minimum wages and pension payments. Firms must raise product prices to pay the higher wages and pensions, fueling inflation. A classic example is Israel, where inflation rose from 13% in 1971 to about 400% in 1984 largely because worker contracts automated pay raises to cover spiraling living costs.  Inflation fed upon itself.

The Times adds:

“...$24 billion in funds of unidentified origin helped to finance half of a record deficit that Turkey racked up last year from importing more goods and services than it exported. Some of that mystery money, reported in 2022 data published by the government last week under the obscure heading ‘Net Errors and Omissions,’ is thought to be of Russian provenance….”

Maybe it’s not such a mystery.  My $1 payment to you is your $1 receipt, which you can spend only on things denominated in dollars. The same is true in international transactions.  If you spend 10,000 tenge on a novel from a bookstore in Baltimore, the bookstore must spend the tenge on Kazakhstani assets.  Sorry, the MacDonalds in Linthicum Heights, Maryland, won’t take tenge for a Big Mac. Believe me, I've tried. Similarly, Russian exporters must invest lira in Turkish assets (including lira reserves).  Granted, the Russians are not celebrated for their transparency.

Another source of “mystery money” is simply that we don’t record all international transactions in the twinkling of an eye. Temporary imbalances between inflows and outflows may show up in “Net Errors and Omissions,” which, far from being obscure, is one of the most thoroughly studied categories in the international accounts. 

The Times seems to suggest that secret Russian funds financed something like half of Turkey's trade deficit (presumably Russia would want political favors in exchange).  But Turkey racked up a trade deficit with Russia of only $3.2 billion.  That is, the Russians had $3.2 billion in lira from trade to invest. The suggestion of $24 billion in secret funds, relative to the known trade deficit, strikes me as unbelievably large. More evidence, please.  –Leon Taylor, Baltimore tayloralmaty@gmail.com

 

Notes

A year ago, the exchange rate was 13.5 lira for one dollar, so the dollar value of a lira was $1/13.5 . Now the exchange rate is 19 lira per dollar, so the lira’s value has fallen to about $1/19. The relative loss in purchasing power is ( $1/19 - $1/13.5 ) / ( $1/13.5 ), or -.29.

      

References

Liz Alderman.  Turkey’s reeling economy is an added challenge for Erdogan.  February 19, 2023.  New York Times.  Turkey’s Reeling Economy Is an Added Challenge for Erdogan - The New York Times (nytimes.com)

Central Bank of the Republic of Turkey. Web page at tcmb.gov.tr

Stanley Fischer and David Osmond.  Israeli inflation from an international perspective. 2000. International Monetary Fund Working Paper.