Turkey’s currency crisis textbook monetary mismanagement

Central banks around the globe are currently staring at inflation rates unseen in more than 20 years.

Supply chain problems and labor shortages arising from the pandemic, combined with sharply rising food and energy prices, have pushed prices up by as much as 6.2% in the US, 4.2% in the UK, 10.7% in Brazil and 4.5% in India. Every central bank has responded by either raising interest rates or committing to raising them in the immediate future.

It’s too early to say whether the new coronavirus variant B.1.1.529, first identified in Botswana and now known as omicron, will take rate-rises off the agenda, but certainly they have not been part of Turkey’s plans. Since September, Turkey has cut interest rates by four percentage points from 19% to 15%, wreaking havoc in the financial markets in the process.

The Turkish lira, which was trading at US$8.28 (£6.21) in early September, fell to $13.40 a few days ago, its lowest level on record at the end of an eleven-day losing streak. It is now trading at around $12.10, having recovered a little but then weakened again as investors move money out of weaker currencies in response to new fears about Covid.

So why has Turkey had such an “irrational” policy stance on interest rates while everyone else is doing the opposite?

Erdoganonomics

It would have been of some academic interest to analyze the reasoning behind such a move, but there has been little forthcoming from the authorities – except to say that it would “boost exports, investment and jobs.”

President Erdogan believes that raising interest rates would raise inflation rather than reduce it and has maintained this view throughout the near 20 years that he has been prime minister (2003-14) and president (2014 to present).

Unlike the 2018 currency crisis, which followed a diplomatic crisis between Turkey and US, the latest debacle is very much homemade and self-inflicted.

Turkish lira vs US dollar