Turkey’s election, which surprised investors by re-anointing Recep Tayyip Erdogan as president, has deepened the country’s economic malaise
Such difficulties are symptoms of eccentric monetary policy. In 2021, facing inflationary pressure that caused central banks everywhere to raise interest rates, Turkey cut them. Believing that low rates lower inflation—the opposite of economic orthodoxy—Mr Erdogan has repeatedly strong-armed Turkey’s central bank to slash its policy rate. Indeed, the overnight policy rate now stands at a cool 8.5%. According to official figures, annual inflation hit 86% in 2022 .
Yet when the theory was put to the test in late 2021, Mr Erdogan was proved wrong. After all, inflation continued to rise. The problem was that the other channels through which interest rates affect inflation dominated the cost channel by which Mr Ertem expected inflation to be reduced, says Selva Demiralp of Koc University.
In the sectors where interest rates are less distorted, though, nominal interest rates have moved in the opposite direction to the policy rate . Since investors do not believe the central bank will act to stop inflation in the future, inflation expectations have risen. This has fed into higher consumer-lending rates, especially for longer-term loans, because investors demand a higher return the lower the purchasing power they expect the lira to hold in the future.
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