This story is about an autocrat who has been in big politics for 20 years. Under his rule, the exchange rate of the national currency has collapsed several times, prices have risen incredibly in the country, and hyperinflation looms on the horizon. At the same time, he calls the central bank’s interest rate the “mother of all evils”, dismisses key officials who dare to argue with him, etc. I will be talking about Recep Tayyip Erdogan, and his experiments with the Turkish economy.
The year 2022. Turkey’s inflation is over 80 percent. How did this happen? The answer is simple – Recep Tayyip Erdogan and his economic theories.
On November 7, 2020, the central bank was headed by a new governor, Naci Agbal. He got the economy in, to put it mildly, not the best form: inflation was already more than ten percent, and even before that, $ 130 billion was spent, or rather burned, trying to support the lira.
After his appointment at the next session on November 20, the head of the Central Bank decided to raise the rate by as much as 4.25 percentage points, that is, to 15 percent, and a month later he raised it to 17 percent.
He continued to be guided by the classical laws of economics and made another increase to 19 percent on March 19, 21. The next day, on March 20, the president fired him, replacing him with the much more loyal head of the Central Bank, who shares Erdogan’s ideas in the field of monetary policy.
By the way, this was already the 4th change of the head of the central bank in three years. As you understand, rulers with authoritarian habits like to appoint those who do not argue with them.
Erdogan believes that he can fix the economy by following neo-Fisherism.
In economics, there is a well-known Fischer equation that looks like this – the interest rate of the central bank depends on the real rate plus the rate of inflation.
From this equation, it becomes clear that the Central Bank’s key rate should be higher than the level of price growth, because inflation is only one component of the equation, and an increase in the bank rate makes loans more expensive, which means less demand for loans, which means the money supply is shrinking, and inflation is decreasing. This is the classic and the only correct interpretation of the Fisher equation, which is used by most banks in the world, and if you figure out this formula, it can tell you how much you can earn on bank deposits.
Let’s assume that the central bank rate is 10 percent, inflation is 8, then you will have a real income of two percent per year, if inflation is 10 percent, then the deposit has not earned anything, and if inflation is 12 percent, then in a year you will lose two percent of the deposit. This is called the Fischer effect, and it shows the purchasing value of money. Let’s consider this situation for example. Sam has $10,000 and he plans to buy a car, but not now, but in a year. He puts money on a deposit at 10 percent, and in a year, he will get back $ 11,000, but the car will also rise in price by the inflation rate of 12 percent, that is, the price increases to $ 11,200. Thus, a year ago Sam could have bought a car, and now he needs to pay an additional $ 200, and usually the experiments with formula stop there, because the latter option does not find practical application in life.
Neo-Fisherists reverse the formula and say that not the real rate is the difference between the bank rate and inflation, but inflation is the difference between the bank rate and the real one, which means if you lower the bank rate with the real rate unchanged, then inflation should slow down. If you look at the formula only on paper, then it can be true, but the world economic community is confident that the theory does not work and is considered to be pseudoscience.
What is happening now in Turkey is a truly historic moment. In fact, the president is inventing a new economy. By the way, it has already been given the name Erdoganomics. His idea looks like this: low rates will provoke a boom in activity, goods will be exported, and foreign currency will arrive in the country, thereby the exchange rate will rise, and inflation will fall.
At least now that’s how people are trying to explain his behaviour now. In my opinion, it is much simpler than it looks. Initially, Erdogan was guided by short-term goals when, in the 2021, he got rid of the head of the Central Bank who disagreed with him, he began to lower interest rates in order to reduce tension in society and give cheap loans to small businesses. Small and medium-sized businesses in Turkey account for ninety-nine and eight percent of all businesses registered in general, that is, large businesses there are only two-tenths of a percent of small and medium-sized businesses that produce more than half of exports and almost three-quarters of the workforce work there. Lowering the interest rate in such conditions worked for a short distance, but in 2021, a collapse began to emerge, which led to inflation at 80 percent, and now it is not clear what to do about it, since if Erdogan retreat, it will mean that the president has shown his weakness.
What then remains? That’s right, to come up with pseudoscientific explanations, as well as to look for enemies on whom you can shift the blame.
In any case, the story is extremely interesting, and very soon we will find out who Mr. Erdogan is, an unrecognized genius or an autocrat who stayed for too long.