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Governor Erdem Başçı |
In the aftermath of
the global economic crisis, the Turkish economy experienced a very strong
recovery. The growth rate reached more than 9 percent in 2010 fueled by an
astonishing loan expansion that reached a 40 percent year-on-year increase.
This expansion provoked a very high domestic demand, which in turn produced a
huge current account deficit (CAD), while the Turkish lira was appreciating
dangerously under the pressure of the flow of hot money. Admittedly, the
Turkish economy truck was going at full speed towards the wall and something
had to be done.
At this difficult
time, the central bank emerged as the unique savior, since the government was
very happy with the growth performance. It was the central bank that took on
the responsibility of tackling the worsening imbalances. The problem was that
one of the rules of thumb in economics is that for each specific goal you
must use one specific tool. Certainly, as the central bank, besides its
unique mission of securing price stability, it wanted to cool the soaring
loan expansion and to address the increasing CAD, preventing the hot money
flows. It had to use an innovative tool like the “daily interest rate
corridor” and a rather old one, the reserve requirements.
The adoption of this
new monetary policy framework immediately raised a hot debate among both
local and foreign economists. Some of them criticized the new policy,
asserting that it was confusing and inefficient. Others supported it, like
Joseph Stiglitz, who suggested that the Turkish Central Bank be nominated for
the Nobel Prize. The public at large has not been interested in this debate,
not surprisingly. Now, the public should be aware that the performance of the
Turkish economy in the near future will depend on the lessons the central
bank and the government took from this experience.
Refet Gürkaynak, a
bright Turkish economist from Bilkent University, who also worked as a
research fellow at the US Federal Reserve (the Fed), discussed this “moving
period” at the Bahçeşehir University Center for Economic and Social Research
(BETAM) seminars last Thursday. Gürkaynak says first of all, that the central
bank was obliged to move because the government was fueling the economy by increasing
public expenditures. In 2011, the government pursued its expansionary fiscal
policy albeit the budget deficit was decreasing due to a rapid increase in
customs revenues. That reduced budget deficit opportunity was indeed a direct
consequence of increased imports widening the CAD and not the result of a
tight fiscal policy.
So, the central bank
increased the reserve requirements in order to cool the credit expansion and
created a new tool, namely the “interest rate corridor,” to produce a
discrete uncertainty about money market interest rates in order to discourage
speculative capital flows (the famous carry trade). The reserve requirement
tool did not work since it put pressure on the deposits rather than on the
credits; banks found other financial resources. The Banking Regulation and
Supervision Agency (BDDK) has been obliged to intervene, albeit late,
increasing the reserve requirements for credits. Credit expansion eased and
the yearly increase declined up to 15 percent. Gürkaynak suggests that this
prerogative has to be given to the central bank, rather than the BDDK. I
agree.
The implementation of
the interest rate corridor also helped. The flow of hot money almost stopped
and the Turkish lira depreciated by approximately 20 percent. The new monetary
policy produced the expected results to some extent: the CAD decreased from
10 percent to less than 7 percent but growth was down to 3 percent, much
lower than expected, and inflation went beyond its target of 5 percent.
Gürkaynak thinks that this adverse side effect is dangerous for the
credibility of the central bank. Indeed, their credibility is crucial for the
success of the inflation targeting plan. He also points out the adverse
effect on investments coming from the uncertainty regarding interest rates,
since this uncertainty is valid not only for hot money but also for other
investors.
I agree with Gürkaynak
that the new monetary framework has been a second best policy. In other
words, it has been a necessity but not an optimal policy. For the future we
need better coordination between monetary and fiscal policy, including
structural reforms. The ball is in the government's court.
Note: These issues
will be discussed by a panel organized by BETAM tomorrow, Wednesday, at 2.30
pm at Bahçeşehir
University featuring
the participation of Central Bank Chief Economist Hakan Kara, Asaf S. Akat
from Bilkent Universty, Cevedt Akçay, chief economist of Yapı Kredi Bank and
Murat Üçer from Global Source Partners.
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