While most countries hiked interest rates in late 2021, Turkey prompted a rate cut. The result. nearly 80 percent inflation. What we can now learn from Erdogan’s daring experiment.
Things take longer than you think. And then they happen much faster than you thought. This is how the important US economist Rüdiger Dornbusch, who died in 2002, described the emergence of a financial crisis. Post Dornbusch uplegs last much longer than seems reasonable or possible before ending just as surprisingly abruptly. A seemingly intolerable situation could last longer than expected.
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If Dornbusch were still alive today, even he would rack his brains at the situation in Turkey. The country has been practicing a daring, idiosyncratic monetary policy for years. Turkish President Recep Tayyip Erdogan believes the interest rate hike is the cause of the price hike rather than an antidote.
While most countries were raising interest rates or preparing to do so in late 2021, it prompted the Turkish central bank to cut interest rates. The result was foreseeable, if not for Erdogan. Within a few months, inflation shot up to almost 80 percent. It is noteworthy that the Turkish economy has maintained its growth. Real gross domestic product rose by 11 percent last year. The upswing in Turkey seems to have no end.
One might conclude from Turkey’s crazy experiment that high inflation is a troublesome but manageable problem. That sounds tempting, but it is a mistake. While runaway inflation has brought a spate of consequences in its wake, three stand out in Turkey: a narrowing of time horizons, pressure on day-to-day decision-making, and an indiscriminate wealth redistribution that shifts the burden of inflation onto those who bear it least able to cope.
First of all, it is about the shortened time horizons. Stable prices give consumers independence from annual changes in average prices. Stability means long-term planning. In Turkey, however, a long period ends with the next month. Because high inflation is fast-moving. Since domestic companies can hardly make reliable forecasts about their expected real earnings, they hesitate to invest in new capacities and opportunities. Long-term prosperity suffers as a result. Added to this are the short-term costs. Vendors don’t have time to wait months for their payments when the money keeps depreciating. As a result, the informal credit and trust on which business relationships are based are undermined.
The decision-making process is also affected. Price signals that should ensure optimal use of resources are distorted. It is no longer possible for companies to distinguish between price increases that serve as information carriers for supply and demand in their respective branch of the economy and those that are a reaction to the depreciation of money. It is equally problematic to achieve a standstill through permanent movement.
In order to keep up with the decline in value, prices have to be constantly renegotiated. That’s exhausting. And society is affected too. The constant haggling creates tensions between firms and suppliers, firms and customers, landlords and tenants.
Related to this is a third major problem: the impact of inflation on the distribution of wealth. Efforts to avoid paying the inflation “tax” tend to amount to shifting it onto someone else. In Turkey, companies are right to complain, albeit mostly in private, about the instability caused by inflation. But Turkey’s larger firms have the resources and know-how to protect themselves from the price hike. The rich secure their wealth with real estate and cash reserves.
The rest of the population is in a less fortunate position. According to a recent survey, more than a third of Turks are no longer able to secure their basic needs. If one also takes into account those who can only just barely secure their supply, the proportion of those affected rises to four fifths. It is clear that the poor suffer most from inflation. But Turkey’s middle class is also struggling. As it loses purchasing power and job security dwindles, a large part slips out of the middle class. This loss of status provokes both fear and anger in many people.
While inflationary policy is generally problematic, the situation in Turkey is particularly tense. Apparently, the majority of voters hold Erdogan responsible for the inflation. In polls for the upcoming elections in June 2023, he and his AK party are far behind. It is now feared that Erdogan could resort to unfair means to maintain power, for example by having his opponents imprisoned or declaring a state of emergency. In this context, Dornbusch’s insight into maintaining the almost unbearable implies something frightening. Because no situation is so bad that it cannot get worse.
The article first appeared in The Economist under the title “Lessons from Turkey on the evils of high inflation” and was translated by Cornelia Zink.
The original of this post “80 percent inflation! What we need to learn from Erdogan’s daring experiment” comes from The Economist.
