Since 2006 Turkish central bank has officially been in pursuance of price stability after reforms such as law amendments regarding the formation of the bank differ the way the bank function. Until 2009, the bank irrefutably had been on the path to achieve price stability. However, in the following years, we have seen the bank using non-conservative tools to reach the desired results that have unsurely included the price stability.
Over the past five years, Turkish central bank has failed to lower the inflation rate to 5%, which it set a long-term target for the price stability, while the rest of the world has struggled to slay deflation. According the December 2015 inflation report, consumer price index in Turkey increased by 8.81% y/y. Food prices have been heavily accused for the higher than expected increase which were up 13.7% (nonprocessed foods). This was highly elusive given the country’s food self-sufficiency. But, more importantly, I-index which excludes food, drink, and energy prices (or core inflation as some say) rose by 9.5%, which clearly reveals the central bank’s painful failure.
Tightening was simply what was expected from the central bank in such cases. Turkish central bank referred to the U.S. Federal Reserve’s policy normalization as the trigger to simplify its own monetary policy. However, after the Fed move in December, Turkish central bank kind of postponed its own normalization process, referring this time to high volatility in the financial markets as a prerequisite. As this was one of the worst cases ever happened in the history of communication in central banking, its credibility got shredded again, worsened already dismal expectations. Now, according to the participants of the survey of expectations, a Turkish central bank reaching its inflation target is unlikely to occur in two years.
It is a fact that Turkish central bank has become less and less resistant to political pressures, as concerns about the bank’s independence have remarkably risen. If so, one should argue that the central bank has also lost its influence on the rates in the credit markets. In other words, politicians’ repeated calls for lower rates to boost growth has resulted in or are to result in with a monetary policy that lacks ability to impact interest rates. See the chart below.
At this point the famous issue of output-inflation trade-off springs to mind, and what is so interesting about the Turkish case is that the central bank has presumably managed to fail in both sides. This all has been a central-bank failure of epic proportions.
The 2001 crisis and the following the post-crisis period were important milestones for economic policy-making in Turkey as well as for the monetary policy. In 2002 Turkish Central Bank adopted a modern monetary policy with primary objective of achieving price stability after the bank had been vested with instrument independence in the previous year. Thanks to these efforts, Turkey has been able to keep the annual inflation rates in the range of 4%-12% after experiencing a hyperinflation period in 90s with 3-digit numbers. Indeed, the posted inflation figures can not be considered as favorable outcomes as they are still above the central bank’s target.
However, the independence of the central bank recently became a point to debate for politicians whom led by President Erdogan, Minister of Economy Nihat Zeybekci and Deputy Prime Minister Numan Kurtulmus who is also a Professor of Economics. Last week (on Jan 16) Mr. Erdogan reiterated his long-established criticism of Turkish Central Bank for not reducing interest rates. Following that, Mr. Zeybekci signaled a change in the law of Turkish Central Bank which organizes the management structure and sets a primary target for the bank. Many pundits attributed this to setting some other targets like growth, employment for the central bank with a law amendment would be a primary agenda item for the new government after the general elections in June 2015.
Interestingly, Turkish Central Bank is more able to cut the interest rates in the upcoming monetary policy committees due to the decline in oil prices and easing inflation rates and is expected to do so by many analysts covering Turkish economics. Therefore Erdogan’s criticism has done nothing but raised the concerns over political pressure on the central bank’s decision. Simultaneously, lira has performed remarkably weaker compared to emerging country currencies, depreciated 2.5% to 2.34 per US dollar.
Post-elections scenarios in Turkey now include a substantial change in the way the monetary policy is made that would lead unpredictable things to occur in Turkish money markets. Investors should carefully keep track of any given remarks by the politicians on the issue.
Inflation targeting is a successfully pursued monetary policy in countries who suffered high inflation for years such Zimbabwe. Turkey also set a new policy framework in purpose to lower the inflation and stabilize the currency rates. Under normal circumstances interest rates are expected to raised by the central bank provided that Turkey is an economy with a huge current account deficit and increasing inflation rate. Rising rates will both make Turkish lira more attractive to carry trade funds to finance the deficit and restrain the household demand that causes high inflation.
However what we recently have seen in Turkey is the politicians arguing against the independence of the central bank, like the ones Zimbabwe who paved the way for the central bank issuing 250 trillion notes. Moreover our politicians are also generating some economics theory that claims high rates cause high inflation. This sounds like tales from the newer-abnormal.
Meanwhile the inflation numbers came out this morning showing that inflation has not lost its momentum yet, contrary to expectations. More terrifyingly everyone in Turkey is so sure that our central bank will recklessly cut the rates with the lower inflation expectations even if the numbers indicate the contrary.
Charts below are explaining.
Governments ignore to learn and memories are short.