How Erdogan’s Unorthodox Views Rattle Turkish Markets

(Bloomberg) -- Turkey’s President Recep Tayyip Erdogan doesn’t like it when the country’s banks charge people relatively heavily to borrow money. That alone doesn’t make him unusual for a politician, given that cheap money can garner electoral support. What makes Erdogan extraordinary is his unorthodox argument for low interest rates and his determination to bring them about by wresting control of monetary policy from central bankers.

1. What’s Erdogan’s beef with high interest rates?

He says that they slow economic growth and that they fuel inflation. The thesis has unnerved international investors for years. While the country’s spending and credit binge during the pandemic propelled growth, the economy has also suffered from double-digit inflation and unpredictable policy moves. He has also referred to Islamic proscriptions on usury as a basis for his policy.

2. Are his arguments reasonable?

The point about weaker growth is. When a central bank increases rates, banks are less able to borrow to maintain mandatory reserves and tend to lend at their own elevated rates. This makes loans for businesses rarer and more expensive and so can slow the economy. But Erdogan’s second notion -- that elevated interest rates cause prices to rise -- contradicts conventional economic theories. They hold that when rates increase, borrowing decreases, leading consumers to spend less and curbing inflation.

3. What’s the basis of Erdogan’s theory?

It’s likely that it’s partly based on his experience running businesses, mostly in the food industry, before his career as a politician took off. Many Turkish companies borrow relatively heavily to cover operating expenses, making volatility in borrowing costs a source of uncertainty and rate hikes an added expense. In Erdogan’s view, higher rates result in higher prices because businesses have to pass on increased costs to their customers. This makes assumptions that orthodox economists challenge, namely that interest rates make up a significant part of companies’ costs and that producers have sufficient pricing power to impose their will on consumers.

4. Who agrees with Erdogan?

The argument is based on a theory by Yale University economist Irving Fisher on the relationship between inflation, nominal interest rates and real interest rates. Critics of the neo-Fisherites say that even if their theory had merit, it wouldn’t apply to an economy like Turkey’s, which suffers from chronically high inflation and is reliant on foreign funding. That’s because cutting interest rates reduces the return on investing in Turkish assets, and the local currency tends to weaken when foreigners decide to put their money elsewhere. That increases the cost of imported goods in liras and results in higher prices, or more inflation. 

5. What has Erdogan done to put his views into action?

While most central banks were talking of tightening policy as the global recovery fueled inflation, Turkey slashed 5 percentage points off borrowing rates from September to December, sending the Turkish lira into freefall. Erdogan explained in November that by reducing rates, Turkey was prioritizing greater investments, exports and job creation in hopes of taming inflation. On Dec. 20 the government responded to the plunging lira by announcing steps including a new program to protect savings from currency fluctuations. Erdogan said the government would make up for losses incurred by holders of lira deposits should the lira’s declines against hard currencies exceed interest rates promised by banks. That sparked the biggest rally for the lira in decades. 

6. What effect has this had on the central bank?

The moves came at the end of a turbulent year. Back in March, Erdogan fired central bank Governor Naci Agbal just days after he raised interest rates. His replacement, Sahap Kavcioglu, the country’s fourth central bank governor in less than two years, is known as an advocate of lower rates. In October, Erdogan used a midnight decree to fire three members of the monetary policy committee who were wary of further interest rate cuts. Back in 2019, Erdogan had dismissed another governor, Murat Cetinkaya, for failing to heed his policies. 

7. Does it matter if Erdogan’s wrong?

Yes, because if he is wrong the lower rates he’s pushing risk weakening the lira in the long term and fueling inflation. Investors also say Erdogan’s forceful drive for lower borrowing costs has made it harder to predict monetary policy and compromised stability. It’s also hurt confidence in policymakers. In other major economies, giving central bankers the autonomy to determine short-term rates is seen as insurance against the impulse of politicians to boost credit, and short-term growth, at the expense of the economy’s longer-term health.

The Reference Shelf

• A QuickTake on central bank independence.
• A Bloomberg story Erdogan’s lira rescue, and another on Turkish inflation.
• A Bloomberg article on the firing of monetary policy makers in October.

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