Why Core Inflation Will Stay High?


Turkish central bank has been failed to use its monetary policy tools to maintain low inflation. The headline inflation rate has been extremely volatile due to fluctuating food prices, while core inflation has remained stubbornly above the target rate of 5% over the past five years. Recently, Turkish economy has seen a glimmer of hope for inflation as annual CPI growth has lowered to 6.6% by 300 basis points in May from 9.6% in January, mostly driven by the impact of lower food prices which is likely to reverse starting June. Meanwhile, the core indicator known as I-index was up 8.77% on annual basis, down almost 1 percentage point since February. Turkish bond markets have enjoyed the indisputably favorable developments on the inflation front. However, we expect this to come to an end being of the opinion that the long-term trend still signals a high core inflation.

Turkey - Headline and Core Inflation

Long-Term Core Inflation Trends

The long-term core inflation trend estimated trend via Hodrick-Prescott filter where lambda value is assumed to be 14,400 as generally accepted while analyzing the monthly data, shows that prices still move upwards in Turkey. More importantly this malign cycle in core inflation is unlikely to finish soon unless the I-index posts large decreases in a short while. With that being said, the cycle, which is shown in dark color and digitized at the right axis, suggests that there still may be some downside potential in the core indicator before a new peak is in the making. We foresee the continuation of the easing in core inflation over the next three months but a high possibility that yearend core inflation rate will be around 9%.

Turkey - Core Inflation Trends

Higher Real Wages to Blame?

One of the most important generalization of the science of economics is that wages are positively related to productivity. And, in a frictionless economy, if wages increase faster than increase in labor productivity, we will have inflation in the economy, equal to that differential. The following is the chart showing how real wages and output per worker has changed since 2010.

Turkey - Real Wages and Producivity

In a previous post we addressed the declining productivity as to what underlies the par below growth in Turkey (see it here: Is Productivity in Decline?). It was many years ago when Marx claimed that productivity growth would eventually reduce wages, apparently, if he was alive, he would be extremely astonished to see the relationship of these two phenomena in Turkey. You may guess the gap will wildly widen after the minimum wage hike. Interestingly, higher wages are expected to lead higher productivity for a number or reasons including motivation to work harder, more capable and productive workers being attracted, lower turnover. The theory simply does not work in Turkey. This is a triumph for workers but a defeat for the central bank as well as the economy after all.