Awaiting the central bank's reaction

Taxi drivers are known as people with a good flair for economic speculation. We, the economists, make predictions based on reflections that combine economic theory and intuition, but we prefer to wait for the largest volume of statistics possible before risking a forecast. When the speed of economic events is rapid, waiting for the statistics becomes very painful, since, as an economist, you have to answer the standard, nasty question: How is the economy going? At those times, the flair of taxi drivers might be a great help.
On Thursday, when I hailed a taxi in front of my university, my driver recognized me thanks to my appearances on TV, and without losing a minute, he asked the famous nasty question. I answered “Not very well,” preferring to remain elusive. My driver reacted immediately, announcing vehemently, “The economy is going very badly.” “Why do you think so?” I asked. Because, he said, “My turnover has diminished by 40 percent since the new year,” adding that the current political crisis is so dangerous that it might lead to a civil war. “God forbid!” I said instinctively. “God forbids this in intelligent societies, not idiotic ones,” he responded. In fact, my taxi driver revealed not only an ambitious flair but also that he is a philosopher.   One hour later, when I was coming back to my office, I compared the flair of my first taxi driver with the new one. He confirmed to me that his taxi's turnover has effectively gone down. To be frank, I had been not thinking that the Turkish economy could be in such bad shape! In my last piece (“Exchange rate debate”) I argued that the duration of the Turkish lira's depreciation would be the determinant of economic growth. In other words, whether Turkey faces a recession or just slow growth will depend on the effects of the evolution of the exchange rate. Now, I think, thanks to the taxi drivers' flair as well as the evolution of the exchange rate since Monday, the risk of recession must be seriously considered. As of Friday, the dollar-Turkish lira parity exceeded 2.20, while it was around 2.17 a few days earlier. What happened in the meantime? Well, the crisis regarding the restructuring of the Supreme Board of Judges and Prosecutors (HSYK) through a new election system has deepened since the main opposition party, the Republican People's Party (CHP), refused the Justice and Development Party's (AK Party) proposal. Then the warnings coming from Europe about judicial independence became more vehement. European warnings must be considered seriously by the government, because they may result in a suspension of membership negotiations with the European Union if the incumbent party insists on its draft law to reorganize the HSYK.   Under these circumstances, the Turkish lira may continue to depreciate further. Even if it keeps its current value in the coming months, I am almost certain that a recession in the first quarter will be unavoidable, and if the political uncertainty is not dissipated, the slow growth that I predicted may become a recession for the whole year. Economic circles are now focused on the Monetary Policy Committee meeting to be held next Tuesday. As I already pointed out, the central bank cannot avoid reacting to this increase, i.e., by further tightening its monetary policy, since its credibility is already being questioned. I believe an interest rate increase has become unavoidable. Some commentators claim that an interest rate increase risks making the recession more probable. I do not agree. If the central bank's reaction is able to reverse the exchange rate and stabilize the USD-TL parity at around 2.10 at least, the damage caused to economic growth by higher interest rates will be less effective than the damage caused by an excessively depreciated Turkish lira. Indeed, in the worst-case scenario, investments and even private consumption risks being seriously affected. What might happen if an interest rate increase remains insufficient to reverse the pessimistic expectations and thus the exchange rate? This is a legitimate question, since the origin of the actual turmoil must be attributed mostly to the political crisis rather than economic factors. Probably an interest rate increase will not be a sufficient remedy, but it will announce, at least, that the central bank is not disoriented by the “interest rate lobby” discourse, and its independence is not in question. The best solution to the current threat is, of course, a compromise on the HSYK dispute between the incumbent party and the main opposition party, as President Abdullah Gül suggests. Nevertheless, if this compromise proves impossible, the central bank must move.