Turkey’s president Recep Tayyip Erdogan has issued a stark warning to his country’s central bank. If he wins a presidential parliamentary election next month, he says he’ll clamp down on central bank independence to keep interest rates low. This is obviously a terrible idea, and comes at the worst possible moment. The lira is in freefall and inflation on the rise. Turkey needs a strong monetary authority, not a stooge obeying the president’s bizarre orders.
Erdogan has long held wrong-headed views on the impact of interest rates. Unlike the vast majority of economists, he believes a tight monetary policy causes rather than tames inflation. In an interview with Bloomberg TV on Monday, he went a step further, saying he was ready to interfere with the central bank if it didn’t follow his advice. “It’s those who rule the state who are accountable to the citizen,” he said.
This shows a blatant lack of understanding of the reasons for central bank independence. Politicians across the rich and emerging world have chosen to delegate monetary policy to independent technocrats precisely because they’re not subject to the same pressures as politicians. Central bankers can raise interest rates when inflation starts getting out of hand, even if it takes a toll on growth and employment. A timely response is crucial to stop inflation spiraling out of control, causing even greater damage.
Central bankers are accountable, of course, but not in the way Erdogan describes. Politicians can demand explanations over the conduct of monetary policy, for example in parliamentary hearings. However, decisions over interest rates need to remain fully in the hands of technocrats. Even a whiff of politicians meddling with monetary policy would make investors fearful that higher inflation is coming – prompting them to flee the country’s currency and debt.
For Turkey, it would be like throwing gasoline on an already raging fire. The U.S. Federal Reserve is relentlessly raising interest rates, pushing up the dollar and borrowing costs across the world. Emerging markets are under pressure as investors shift their money back to the U.S., prompting falls in local currencies and a spike in some country’s bond yields.
The Turkish economy is at the forefront of this great rush for the exit, because of its vulnerabilities. Turkey runs one of the widest current account deficits in the world: 6.5 percent of gross domestic product on a yearly basis. Rising oil prices, and the government’s expansive fiscal policy mean this gap will stay high, even though exports are actually rising. With inflation at 10.9 percent, the economy shows clear signs of overheating. Investors are responding accordingly. The Turkish lira has depreciated by about 15 percent against the dollar since the start of the year. The yield on 10-year government debt has climbed above 7 percent, up from 5.2 percent in January.
The central bank has tried to respond to the crisis and bring inflation back near its 5 percent target. At the end of April, it increased one of its key interest rates – the liquidity window rate – by 0.75 percentage points, bringing it to 13.5 percent. As the crisis intensifies, the bank needs the political space to act more aggressively. Erdogan’s comments undermine even the most timid efforts to get on with the job.
The Turkish president might soon regret his words. Unless Turkey raises interest rates, and cuts spending, the economy could be in for a very hard landing. Potential autocrat or not, Erdogan needs Turkish businesses and consumers – and international investors – on his side.
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