By mid-2023, the administration realized that the “non-orthodox” monetary policy in place for the preceding 4 years was dragging the country into dead ends, with rapid increases in inflation creating massive imbalances. In that episode, the economy came to the verge of collapse caused by the central bank reducing policy interest rate from the last quarter of 2021 to the middle of 2023.
The administration, than, changed the economic management in order to change the policy.
By now, it has become clear that the return to normalcy will not be as easy as thought.
Inflation in Turkey carries both demand and cost components. Demand is brought forward as a result of the flight from money created by high inflation. We can observe this from full occupancy of restaurants, cafes and shopping malls around us, the liveliness of shopping and the endless traffic jams. The rise in inflation and the concomitant demand for foreign exchange naturally trigger an increase in exchange rates, which leads to an increase in costs and cost inflation, and so on and so forth.
Three important steps have been taken so far in the field of monetary and exchange rate policies to return to orthodoxy: (1) The policy rate was gradually increased from 8.5 percent to 42.5 percent. In parallel, banks’ deposit interest rates reached just below 50 percent. Considering bank deposit rates soared from 10 percent prior to end-May election to current day, we can say that this is a significant remedy. (2) The exchange rate protected deposit accounts (KKM) are being gradually liquidated. We can also observe that the increase in TL interest rates mostly prevented savers from demanding foreign currency after the exiting KKM. (3) The Central Bank started open market operations to reduce liquidity in order to limit foreign exchange and private consumption demand. For this purpose, the bank aims to reduce the amount of money in the market by organizing Turkish Lira purchasing auctions (reverse repos).
Yet, there is still a monetary development that contradicts the monetary policy steps that aim to limit demand and therefore control demand inflation: The money supply continues to increase. M2 broad money supply has increased by 61.8 percent since the beginning of the year. In the same period, inflation increased by approximately this much. Now the Central Bank wants to restrain the money supply by reducing liquidity in the market.
Monetary policy is not enough to control inflation.
Although monetary policy has been used as the main tool in recent years, fiscal policy should not conflict with monetary policy; and should be shaped to serve the same purpose. In an environment where interest rates are increased, liquidity is withdrawn from the market, and KKM accounts are liquidated, the increase in public sector expenditures reduce the effectiveness of monetary policy. A similarly distorting effect occurs by increasing the rates of indirect taxes such as VAT and Special Consumption Taxes, which are immediately reflected to final prices.
One of the most important components in the fight against inflation ought to be to target the informal economy. Thus, a larger segment of society will be taxed without imposing new direct taxes or increasing their rates. While this will be effective in fighting inflation, it is also important in preventing unfair competition and finding additional sources of revenue for the state.
The only meaningful measure taken so far to combat inflation is to gradually raise interest rates. Since perceived inflation is at least twice as much as announced, these increases are only moderately effective. There is no meaningful effort to reduce wasteful expenditures of the public sector. In other words, fiscal policy does not seem to help monetary policy. Structural reforms have never been undertaken anyway.
In order to reduce inflation, monetary and fiscal policy must be in harmony. While monetary policy measures are taken to reduce demand, on the other hand, public expenditures continue to increase demand in order to keep growth high, the positive contribution of monetary policy disappears.
At this rate, inflation will rise again after falling due to the base effects.
Who is Mahfi Egilmez
Mahfi Egilmez is one of Turkey’s most prominent economic analysts. He completed his PhD in Public Finance at Gazi University. In 1997, he was appointed Undersecretary of the Treasury. Mr. Egilmez was a columnist for Radikal Newspaper, Yeni Yüzyıl and the monthly CNBCe Business magazine. He was a commentator for NTV television channel, for 10 years and taught economics at Istanbul Bilgi University and Kadir Has University. He is currently teaching at Altınbaş University. He has published 20 books and many articles.