The Kapali Carsi

Turkey: Erdoğan’s Way – in Monetary Policy

Below is the weekly guest column by Taylan Bilgic, which was published today at Hurriyet Daily News. My comments are, as always, right below the column.


[The market had barely finished buzzing around the Turkish Central Bank of Gov. Erdem Başçı’s statement Jan. 6 on how 2012 would be “the year the Turkish Lira will beat the dollar” when even more dramatic words came from Prime Minister Recep Tayyip Erdoğan himself.

Speaking Jan. 10, Erdoğan claimed the current account deficit was “now in order” but pointed toward the “new threat” of the “interest rate lobby.” I will include long quotes because the statement, while underlining once again Erdoğan is the one who calls the shots in Turkey, also reveals a “merchant perspective” of the world.

“We cannot have the interest rate lobby operate as such,” the prime minister was quoted as saying. “The more vicious the interest rate lobby, the more diminished the purchasing power of our citizens – who are the consumers – will be. Also, entrepreneurs will be forced to cut down on investment, because as seen in loans, interest rates are high. The policy rate is around 5.8 percent. However, market interest rates are hovering around 13-14 percent.”

Emphasizing the need to close this gap, Erdoğan repeated his belief that as market interest rates rise, so will inflation. “I do not take other [interest rates] seriously,” he said. “But as much as we lower the market rate, inflation will be lower… Unfortunately, as the market rate rose to around 14 percent recently, inflation also rose to 10.45 percent.”

I will not indulge myself with the claim on the interest rate-inflation correlation, or what caused the market rates to rise, or who put the brakes on loan growth, or the reasons for double-digit inflation. A cursory glance at economic developments of 2011 would suffice to set the record straight on these. In regards to the current account deficit, as of November, the 12-month rolling gap fell to 10.2 percent of GDP from 10.3 percent of GDP, according to an Erste Securities report. How the decline can point at the end of the problem is also beyond me.

What is more interesting is the outcome of such tough rhetoric: Political opposition to the government has, for some time, been under serious risk of “Ergenekonization” by being labeled pro-coup and anti-democracy. Now, it seems, criticizing economic and monetary policy risks being labeled “interest rate lobbying” by being an enemy of growth and prosperity.

This tactic could work in the short term; notice many market players have been talking “anonymously” to the press for some time now. A “death to the lobby” themed story run by Sabah newspaper yesterday included an admission six Turkish banks refused to comment, for example.

However, in the long run, such rhetoric can only mean policymakers are painting themselves into a corner regarding choices. They won’t be able to raise the policy rate in the future even if they want to do so.

Adapting to change and mastering pragmatism was what saved Erdoğan and his Justice and Development Party many times in the past. Today, in the face of approaching regional and global storm clouds, those key traits look increasingly vulnerable.]


I do not comment much on Taylan’s political stuff, since I don’t like to talk about things I don’t really understand, but this is my turf, and I have a lot of things to say.

Let’s start with the PM’s speech. It got a lot of international attention, with WSJ and Bloomberg covering the story, among others. Pro-government daily Sabah did not miss the golden opportunity, running consecutive full-pagers yesterday and today, claiming that the leader of the interest rate lobby was the Rothschild family. They also managed to attack RBS as well, which is the bank where Tim Ash, one of the prominent members of the lobby, works, as well as include some comments about the lobby from the street.

It was therefore a relief to see some reason in the Turkish press, other than Taylan’s column, among all this madness. Radikal columnist Ugur Gurses makes the point, in his column today, that banks win and savers lose from lower rates. And Mahfi Egilmez was urging those who claim there is an interest rate lobby to find a hobby (nice play on words); in other words “to get a life“.

Then, there was a heated debate yesterday on Twitter that high interest rates indeed cause inflation. I just watched the morning show of economist Emre Alkin, one of those who claim they do. It seems that he is using the standard quantity theory of money argument, that inflation is a monetary phenomenon.  Basically, he is saying that as you increase interest rates, you will increase M2 (he calls that bank money), which will result in inflation. The relationship between money and inflation may hold in the long run, when we’ll all be dead:), but let’s see how this argument holds up against data:

Hmm, even without testing for causality, this doesn’t look like a perfect relationship, does it… Joking aside, I think Alkin is confusing symptoms with the disease itself. You could argue that inflation was driven by a credit boom, but this credit boom is the result of an overheated economy, which doesn’t have much to do with all the money in the banks. And if the relationship was so simple, we should be seeing serious inflation in the U.S. now, as the yearly growth of M2 illustrates:

fredgraph M2 growth_120113

Also note that there isn’t a relationship between money growth and interest rates, so maybe I didn’t even need to look at the relationship between money and inflation at all!

Another variant of the theory, attributed to Garanti Yatirim strategist Tufan Comert (it seems he was only joking but was taken seriously; he told me he’d explain at his blog, I’ll link to him as soon as he does he has published his arguments in his blog unfortunately, they are in Turkish, but he is basically saying he was entertaining this idea at a bar -the Turkish equivalent of the Laffer curve story, if you know the story- a few days ago; that it is a hunch, and that he has not really tested it out), is that higher interest rates increase inflation by increasing inflationary expectations. The argument is that when people see that deposit rates are higher, they will want to increase the rents for their houses and so on. Let’s see how this theory holds in graph:

Not bad! Not bad at all! Until you realize that there might be a third factor that increases both interest rates and inflation expectations, what economists refer to as the omitted variable bias. So what may be the omitted variable?

Our good old friend inflation. In fact, if you just look at the relationship between the two by naively regressing inflation expectations against interest rates, you see that the coefficient on interest rates becomes insignificant once you add inflation as an independent variable (I’ll do a more rigorous version of this for next week’s Daily News column).  I also tried to see if interest rates cause inflation, but no luck there, either.

Intuitively speaking, I wouldn’t expect someone to increase his inflation expectations (or increase the rent of his apartment)  just because he is getting 10 percent rather than 8 percent at the bank, and they don’t!

But the PM should not worry. You do get a relationship if you look at inflation and interest rates over the long haul:

So the lesson of the day: You should not confuse correlation with causation:)…

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