Güldem Atabay: The Death of a Central Bank

The Turkish central bank’s Monetary Policy Committee (MPC) kept the benchmark interest rate steady at 19 percent as expected last week.

However, the MPC signaled that Turkey is now on the path to monetary easing in the wording of a text accompanying the decision. It is unclear why Turkey would move towards more lax monetary policy that would further support economic growth when inflation is at 16.2 percent, almost twice as high as the bank’s own year-end estimate of 9.4 percent and more than three times the official 5 percent medium term target.

In the MPC text, the central bank emphasised that the global economy is on track to post faster growth and that commodity prices were rising.  So, can it be that the bank is expecting declining commodity prices in the coming months? After all, if oil prices were suddenly to fall, one of the cost-side pressures on inflation in Turkey would be eradicated. Yet, there is no explanation. The bank merely notes that the pace of commodity price increases is slowing.

Inflation pressures are growing globally partly due to rising commodity prices. The MPC statement in March, drawn up under previous governor Naci Ağbal, stated that rising inflation expectations were creating uncertainties in the monetary policies of developing economies and volatility in their currencies.

Could it now be that the current MPC does not care about global inflationary concerns? New governor Şahap Kavcıoğlu, appointed by President Recep Tayyip Erdoğan to replace Ağbal in the middle of last month, is a monetary policy manager in a developing economy. Could it be that he is saying we should no longer be worried about rising global inflation expectations because he is trying to underline that the only way is down for Turkey’s policy rate? Who knows?

When mentioning domestic demand, the strong manufacturing industry and weak services sector in the MPC statement, why would Kavcıoğlu and his colleagues erase a sentence in the March statement that said “services sector activity will accelerate following the easing of curfew measures”?

Does Kavcıoğlu think that weakness in the services sector, which will continue for at least another month given the new peak in the pandemic, will help ease inflationary pressures going forward? Or is he suggesting that we should simply ignore a possible pass through from producer price inflation of 30 percent to consumer price inflation of 16 percent as the services sector recovers in the summer months… He does not provide an answer to that question either.

Kavcıoğlu and his colleagues also chose to adjust a sentence in the MPC statement in March that warned of the negative risks to economic activity from COVID-19. Instead, they spoke of “risks in ‘both directions’ depending on the course of the epidemic and the vaccination process”. Could it be that Kavcıoğlu does not want to undercut the so-called “great success” of the government’s vaccination program by spreading negative propaganda through monetary policy? Well, better not.

By completely erasing a phrase stressing the “cumulative effects of high credit growth provided during the epidemic”, is Kavcıoğlu subliminally trying to bury a scandalous loss of $128 billion in the central bank’s foreign exchange reserves last year? These loans were distributed at a time when the central bank was selling its foreign currency reserves, in an undisclosed manner, to give the fake impression of a stable lira while it kept interest rates a below inflation. Or was the exclusion of the phrase designed to cloak the high and uncontrolled inflation generated by this enormous credit-based growth and to put monetary easing on the agenda as soon as possible? The answers are not clear.

In its March statement, the MPC talked about the vibrancy of the Turkish economy, pointing to a recent increase in banks’ loan books despite the tightening of financial conditions.  Why now, in Kavcıoglu’s first MPC meeting, would the bank choose to talk about commercial and consumer loans separately and to stress how commercial loan growth was mild and consumer loan growth relatively stronger? Could it be to emphasise how high interest rates are hitting companies and their investments and to lay the ground for support for the corporate sector?

Why would Kavcıoğlu only mention that inflation was accelerating due to “elements of demand and cost” when the central bank had listed “domestic demand conditions, cumulative cost effects, especially the exchange rate, and international food and commodity prices” in the previous MPC statement?

Kavcıoğlu argues that “the current monetary stance is expected to slow down loans and domestic demand in the coming period”. He ignores the details provided in the previous MPC text that emphasised the “recent upward trend in credit growth and the increase in import costs”. Does the central bank think such ongoing inflationary pressures will disappear?

Could a “promise to keep policy interest above inflation” mean “tight monetary policy” when it is clear from the statement that the central bank sees no inflation risk from rising credit growth?

Furthermore, what is Kavcıoğlu’s purpose when he removes the bank’s decade-old emphasis on “every new data announced and news disclosed might cause the MPC to change its policy stance”?

The central bank provides no answers to any of these questions. If strong communication and predictability of central bank policy are essential parts of inflation targeting, this latest MPC text might mean that inflation targeting is effectively pushed aside.

Kavcıoğlu had previously signalled that we should not take into account what he wrote when he was a newspaper columnist, namely supporting Erdoğan’s unorthodox theory that high interest rates are the cause of high inflation. If we cannot figure out the economic basis for the looser monetary policy signalled by the central bank in the MPC notes and if we do not understand what messages are intended through the changes in the text, then at least one thing is clear – the Central Bank of the Republic of Turkey no longer sets the country’s monetary policy.

Then, where do we get the information we need to assess policy direction and the reasons for it, if not from the central bank?

Unfortunately, we are left with no one other than Yiğit Bulut, the former TV anchor, senior economic adviser to Erdoğan and member of the president’s Economic Policy Board. Bulut appeared on Turkish TV channels to lay down how monetary policy would develop in the term of the new governor the day before Kavcıoğlu’s first MPC meeting.

Bulut, who seeks to demonise most economists because they reject the insanity of Turkey’s macro economic management argues:

“Increased investments do not mean breaking away from financial discipline. Financial discipline does not necessarily mean squeezing and stifling the market. On the contrary, production, investment and employment can be increased without disrupting financial discipline.

“No one should read into the intents of the central bank. Whatever the conditions of the market and the economy require, the central bank will take those steps and the necessary decisions will be taken.

“With the U.S.-EU axis on the West side and the China-Russia axis on the East side… Turkey is the most important country in the new world order. This will lead to the emergence of a new economic model, the complete defeat of classical hot money supporters and a new wave of investments directed to Turkey, no matter what side Turkey chooses.”

The future of monetary policy is much clearer from Bulut’s words than the MPC text.  Hence, let us be prepared to see Turkey’s first interest rate cut in June.  Never mind the strength of domestic demand, the increase in credit growth, the rise in commodity prices, the supply problems caused by the pandemic, the melting down of the lira, and even high inflation itself, which is no longer important according to the “higher vision” of Turkey.

The only truth to dominate is the vision of Erdoğan’s army of economic consultants who have the illusion that Turkey’s economy will be the harbinger a “new macroeconomic era” in the world.

It is an experiment that will soon face a catastrophic end and take its place in macro-economic literature as an example of how an economy should not be managed.