Last week we witnessed a furious debate over monetary
policy (see my piece “The fault line under the central bank,” May 30).
A profound disagreement has clearly appeared between Prime Minister Recep Tayyip Erdoğan, supported by his inner circle, on the one side and the central bank, supported by Deputy Prime Minister Ali Babacan and Finance Minister Mehmet Şimşek, on the other. It is obvious that the prime minister completely disagrees with the current monetary policy. He firmly believes that high interest rates are the cause of inflation and that there is no link between interest rates and the exchange rate. Moreover, Mr. Erdoğan is afraid that the current level of interest rates for loans prevents investment while Economy Minister Nihat Zeybekçi claims that high interest rates undermine growth and employment.
Deputy Prime Minister Babacan and Finance Minister Şimşek tried to calm Prime Minister Erdoğan down through various statements, claiming that the central bank's independence constitutes a critical element of macroeconomic stability. Turkish Central Bank Governor Erdem Başçı then made a presentation on Monday to the Cabinet. After the Cabinet meeting, government spokesman Bülent Arınç stated clearly that the government had defended in the past and will continue to defend in the future the independence of the central bank. After this official engagement, I believe one of the critical items of the debate has now been clarified: There will be no change in the central bank law as was requested by some counselors close to the prime minister. We might speculate that the prime minister has been convinced that changing the central bank law by introducing new clauses to either restrict its policy independence or add growth goals beside price stability as its mission would be a very dangerous step forward regarding investor confidence.
Nonetheless, the prime minister does not seem to be convinced about the monetary policy based on the arguments of Governor Başçı in his presentation. Indeed, he declared a day later that he does not believe the current policy is positive and desires new steps to be taken very soon with respect to interest rates.
On the other hand, Governor Başçı's defense in his presentation can be summarized into five points: 1) If a strong interest rate increase is not implemented (by the end of January), expectations of the exchange rate and inflation will worsen, pushing the long-term interest rate up even more; 2) Do not worry, inflation will start to decline and we will proceed with interest rate cuts accordingly; 3) Real interest rates are about 2 percent -- Mr. Erdoğan had previously claimed that they are at 4-5 percent -- and they are no higher than the real rates prevailing in emerging markets; 4) Gross domestic product (GDP) growth is currently close to 4 percent and, moreover, is balanced; and 5) The current account deficit (CAD) is decreasing thanks to balanced growth.
Needless to say I fully agree with Mr. Başçı. The economy is going through a necessary adjustment period. Reducing both inflation and the CAD require strict control over domestic demand as well as a stable exchange rate. However, Mr. Erdoğan is basically concerned about economic growth. He is not happy with a rate of under 4 percent even though it is balanced, which is, in fact, the main official goal of the economic governance headed by Deputy Prime Minister Babacan. Mr. Erdoğan is right as well since GDP growth of under 4 percent would not be sufficient to reduce unemployment and increase public spending. He needs a booming economy in electoral periods, all the more since Justice and Development Party (AKP) votes are on a decline as evidenced by the electoral outcome of the local elections on March 30.
What will the next episode look like with the profound disagreement over monetary policy? I think the prime minister will wait for a few months in order to observe the basic economic figures. The first critical revelation will be the publication of the GDP figures for the first quarter on June 10. If the growth rate is well below 4 percent, one can expect a harsh reaction from the prime minister. The second critical item will be the evolution of inflation. It is expected to decline from June onwards. This would allow the central bank to reduce interest rates to some extent. The recent monetary loosening measures taken by the European Central Bank gave the central bank additional room in this respect. But one doubts the size of interest rate cuts would satisfy Mr. Erdoğan. The fight over monetary policy is not over.
A profound disagreement has clearly appeared between Prime Minister Recep Tayyip Erdoğan, supported by his inner circle, on the one side and the central bank, supported by Deputy Prime Minister Ali Babacan and Finance Minister Mehmet Şimşek, on the other. It is obvious that the prime minister completely disagrees with the current monetary policy. He firmly believes that high interest rates are the cause of inflation and that there is no link between interest rates and the exchange rate. Moreover, Mr. Erdoğan is afraid that the current level of interest rates for loans prevents investment while Economy Minister Nihat Zeybekçi claims that high interest rates undermine growth and employment.
Deputy Prime Minister Babacan and Finance Minister Şimşek tried to calm Prime Minister Erdoğan down through various statements, claiming that the central bank's independence constitutes a critical element of macroeconomic stability. Turkish Central Bank Governor Erdem Başçı then made a presentation on Monday to the Cabinet. After the Cabinet meeting, government spokesman Bülent Arınç stated clearly that the government had defended in the past and will continue to defend in the future the independence of the central bank. After this official engagement, I believe one of the critical items of the debate has now been clarified: There will be no change in the central bank law as was requested by some counselors close to the prime minister. We might speculate that the prime minister has been convinced that changing the central bank law by introducing new clauses to either restrict its policy independence or add growth goals beside price stability as its mission would be a very dangerous step forward regarding investor confidence.
Nonetheless, the prime minister does not seem to be convinced about the monetary policy based on the arguments of Governor Başçı in his presentation. Indeed, he declared a day later that he does not believe the current policy is positive and desires new steps to be taken very soon with respect to interest rates.
On the other hand, Governor Başçı's defense in his presentation can be summarized into five points: 1) If a strong interest rate increase is not implemented (by the end of January), expectations of the exchange rate and inflation will worsen, pushing the long-term interest rate up even more; 2) Do not worry, inflation will start to decline and we will proceed with interest rate cuts accordingly; 3) Real interest rates are about 2 percent -- Mr. Erdoğan had previously claimed that they are at 4-5 percent -- and they are no higher than the real rates prevailing in emerging markets; 4) Gross domestic product (GDP) growth is currently close to 4 percent and, moreover, is balanced; and 5) The current account deficit (CAD) is decreasing thanks to balanced growth.
Needless to say I fully agree with Mr. Başçı. The economy is going through a necessary adjustment period. Reducing both inflation and the CAD require strict control over domestic demand as well as a stable exchange rate. However, Mr. Erdoğan is basically concerned about economic growth. He is not happy with a rate of under 4 percent even though it is balanced, which is, in fact, the main official goal of the economic governance headed by Deputy Prime Minister Babacan. Mr. Erdoğan is right as well since GDP growth of under 4 percent would not be sufficient to reduce unemployment and increase public spending. He needs a booming economy in electoral periods, all the more since Justice and Development Party (AKP) votes are on a decline as evidenced by the electoral outcome of the local elections on March 30.
What will the next episode look like with the profound disagreement over monetary policy? I think the prime minister will wait for a few months in order to observe the basic economic figures. The first critical revelation will be the publication of the GDP figures for the first quarter on June 10. If the growth rate is well below 4 percent, one can expect a harsh reaction from the prime minister. The second critical item will be the evolution of inflation. It is expected to decline from June onwards. This would allow the central bank to reduce interest rates to some extent. The recent monetary loosening measures taken by the European Central Bank gave the central bank additional room in this respect. But one doubts the size of interest rate cuts would satisfy Mr. Erdoğan. The fight over monetary policy is not over.
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