The year 2022 witnessed high inflation across the globe, a rare phenomenon unseen in decades. The annual inflation rate for the United States reached 9.1% in June 2022 before it slightly pulled back to 8.5% in July. Inflation rate in the European Union climbed to 9.8% in July from 9.6% in June. U.K. inflation increased to 10.1% in July from 9.4% in June.
There is one country that stands out among all the sizable economies suffering from rising prices. The annual inflation rate in Türkiye accelerated for the 14th consecutive month to reach 79.6% in July of 2022, the highest since September 1998.
Underlying reasons for worldwide high inflation include disrupted global supply chains, excess stimulation packages by many governments to fight COVID-19, and the war in Ukraine that pushed energy and food prices to high levels.
Yet in Türkiye there is a unique cause attributable to its one-of-a-kind monetary policy.
As a general practice, central banks, when faced with high inflation, raise interest rates to increase the cost of financing, thus curbing expanding activities and discouraging demands in the whole economy. As the economy slows down, prices would then pull back to acceptable levels.
However, that is not how they rein in inflation in Türkiye. Its central bank shocked the market with a policy rate cut in August. The country’s main policy rate, at 14% for the previous 7 months, was cut to 13% in a complete mismatch to the practice of other central banks around the world.
Turkish monetary policy is under the direct control of its President Recep Tayyip Erdoğan, who spearheads an unorthodox approach to solving the inflation puzzle.
Roughly, the underlying rationale seems to be that high interest rates make economic activities very expensive. By lowering interest rates, businesses will have lower financing costs and more products will be economically produced. The abundance of products will then bring down prices.
There are obvious flaws in this way of thinking. A lower interest rate itself cannot actually bring down the cost of production in an overheated economy. On the contrary, easier access to capital and its resulting excess liquidity makes goods more scarce compared to money.
Cemil Ertem, one of the president’s economic advisers, tried to draw some academic support from the work of Irving Fisher, whose neo-Fisherism suggests that in the circumstance of consistently subdued low inflation in developed countries, central banks can increase inflation by increasing their nominal interest rate targets.
“A model applicable in one situation is not necessarily useful in another,” Bulent Gultekin, associate professor of finance at the Wharton Business School and former governor of Türkiye’s central bank, told Al-Monitor, an independent Middle East news source, in 2018.
For Gultekin, Ertem’s invocation of neo-Fisherism is a “smokescreen that has no economic validity.” “For small economies like Türkiye, such policies are like throwing petrol on a fire,” Gultekin said.
Neo-Fisherism has not been accepted by the mainstream, by the way.
Adopting such a controversial monetary policy without sound academic foundation is a risky move. It is perhaps a better practice to resort to conventional wisdom and shun abnormal experimental approaches in governing a country.
One thing is for sure: This insanely high inflation is taking a heavy toll on the Turkish economy and the lives of the Turkish people.
(The author is an independent financial investor.)