The most common question on most minds nowadays would probably be the concern regarding how Türkiye is planning to bring inflation down and prop up the Turkish lira. Furthermore, why won’t policymakers raise interest rates like the U.S. Federal Reserve (Fed) or the European Central Bank (ECB)?

First of all, in Türkiye, neither the central bank nor the government officially has a specified exchange rate target. Exchange-rate stability could be considered part of the broader financial stability mandate, though.

Also, in Türkiye, policymakers don’t believe inflation (for instance) is due to demand-driven (demand-pull) factors. It is more due to supply-side (cost-push) factors, they reason. Hence, more supply-side and self-driven factors, including the built-in expectations and exchange-rate movements (and even the current account deficit and commodity dependence on other countries), affect the widespread nominal volatilities. In the exchange-rate volatility case, additional speculative motivations and worsening expectations also play a role.

Hence, communication and enhanced expectations management are key to managing all these little volatilities. However, the widespread interest rate instrument is a rather demand-side policy tool. One should also remember that an interest rate instrument is a temporary solution. It would buy time to resolve more fundamental issues.

Therefore, policymakers should actually (in the end) focus on more fundamental solutions. Meanwhile, the post-World War II Keynesian approaches built around the interest instrument must also be updated. Yet, of course, it would have to be done gradually and planned in advance. Türkiye also aims to decrease the external finance needs (aiming at the core of the problem) and is willing to solve this "debt-exchange rate-inflation-interest rate" devil’s circle once and for all.

Thus, the country could (indeed) have used the interest rate instrument again to prop up the lira temporarily. But it seems like it preferred to look deep inside. Furthermore, there were issues in the implementation of its unconventional policies too. For example, communication of these new policy instruments and the speed and timing of the rate cuts were all challenging. Time consistency is also crucial. So you got to be consistent in your policy implementations.

Heterodoxy, on the other hand, means ensuring the irrelevancy of or cutting out the interesting instrument (the post-Word War II primary policy instrument). You have to target the fundamentals (leading to this huge volatility). Accordingly, policymakers also seem to have planned to rather focus on the current account deficit, low savings, and lower cost of production and investment.

Economic activity

Low costs and rates have indeed triggered production, more investment, growth and employment, the four pillars of the Turkish Economy Model (TEM). As a result, growth rates were 5.6% in 2022, 11.4% in 2021, and 1.9% in 2020.

These relatively lower interest rates did (indeed) help growth, but that is not the whole story. Türkiye is building its production base in the bigger picture. The four pillars of the TEM (production, investment, employment and export) each seem to be extremely important. Low-cost investments and much higher production, jobs and exports have significantly contributed to the recent economic transformation.

In that sense, Türkiye opted for growth and more employment at the cost of higher inflation in 2022. It has preferred inflation to the recessionary trends. Expansionary monetary and fiscal policy, lower interest rates, liquidity and credit abundance were effectively used to increase investment, production, and employment and to revive economic activity.

Policymakers aim to increase production, investment, employment and exports via lower interest rates. With the help of these types of (mostly) supply-side policies, credit capacities are expanded, and the cost of production finances is brought down. In addition, monetary and fiscal policy coordination was effective. The monetary policy brought down rates and increased credit capacity, while the budgetary policy decreased taxes and raised subsidies.

The unemployment rate is relatively low nowadays, at around 10%, as production, employment and investment have gained priority. Production economy, expanding the production base and new investments have all helped increase employment. Even the labor force participation rate is up to 54% nowadays.

Employment in Türkiye is currently over 31 million. It used to be at 19 million in 2003. A few more million were added in the past two years alone. Therefore, the 10% unemployment rate might seem a little high and should indeed be reduced further in the medium-to-long run. But each country should also be evaluated in its own circumstance (and on its own long-term path).

Lowering rising volatilities

High inflation, interest rate and exchange-rate volatility (the devil’s triangle) are post-election priority issues to contemplate. Türkiye is also adding the chronic current account deficit to this priority list. However, market equilibrium and supply security (particularly in the agriculture and energy sectors) should first be guaranteed to deal with these huge nominal volatilities.

After all, a huge current account deficit and external finance need also lead to exchange-rate and inflation volatilities by raising the costs and prices and importing external inflation. Most of this domestic current account deficit is, meanwhile, due to the gold imports, energy imports and intermediary goods and service imports of the growing Turkish economy.

Türkiye is already on a path to decreasing its current account deficit with new energy discoveries, nuclear reactors and renewable energy investments, among others. Uncertainties (policy-wise, political and financial) will also be much lower looking forward. This type of uncertainty and lack of expectation management lead to self-fulfilling price prophecy and hence much higher nominal volatilities.

Overall, it seems like supply-side policies will be prioritized in the fight against the already-high inflation and other nominal volatilities. Because policy-makers in Türkiye believe inflation (at home) is primarily due to supply-driven factors. That is also why they are (predominantly) aiming for supply-side policies and even lower interest rates to bring down the costs of finances.

Lowering inflation (currently at around 43%) should indeed be a priority. And the base effect will be one critical factor at this point. Increasing production and focusing on the supply side should be the second critical factor. Exchange-rate stability, stabilizing food and energy prices, other commodity prices, agricultural reforms, energy investments and decreasing external dependence should all help as well. The long-standing "debt-exchange rate-inflation-interest rate" devil’s circle should be ended for good. It will also be a critical factor in financial stability. The relative stability in interest and exchange rates will also help manage expectations and the exchange-rate pass-through effects over domestic prices. Monetary tightening, weaker demand and even recessionary expectations in tightening economies might all help cool down the prices.

However, not just the interest rate and exchange-rate connection (as in the devil’s triangle) but the structural aspects should also be considered. In this context, policymakers aim to increase production, investment, employment and exports via low-interest rates. With the help of these types of supply-side policies, Türkiye aims to bring down the chronic current account deficit and once again decrease inflation to the single digits.

Supply-side policies in the housing sector and goods market, energy and commodity import decreasing policies (nuclear reactor, natural gas and green energy investments), new trade routes, and chip production will all be crucial. The housing sector and the auto industry are two such critical, popular areas. Natural gas in the Black Sea reserves is currently being transferred to onshore plants. The first national electric vehicle (Togg) has already hit the roads.

Turkish policy-makers summarize the fight against inflation as a lasting process and an integral part of supply-side policies, including more investment, production, export and increased employment capacity, as opposed to short-term monetary tightening policies (implemented in the West) contracting demand, investment, production and employment.

Low rates not only decrease the cost of investment, production and employment but also lead to lower cost of production and hence lower inflation rate. In addition, subsidies in (and sometimes even free of charge) energy and other commodity markets also help reduce inflation figures.

The opposition in Türkiye, on the other hand, seemed to plan to resort back to conventional textbook solutions. They seemed to be willing to raise policy rates again, among others. It is unclear, though, how it would help since it did not before 2002. Plus, we don’t have the liquidity abundance of post-2009, or the trough of post-2001, to use as leverage.

Though, we should probably not just focus on one single instrument either. Türkiye is much bigger and more diverse. Going back to the conventional policy measures might not suffice. Especially a demand-side mechanism (when the problem could actually be on the supply side)... The structural aspects of the problem should also be considered.

Meanwhile, the world is also moving away from neo-liberal prescriptions, and the one-size-fits-all policy approaches could also be problematic. They usually do not work for other rising economies either. Countries such as Türkiye cannot follow the policy prescriptions of the most advanced economies. Türkiye needs to grow, invest, export and employ more of its citizens.

Rising rates

Rising interest rates (on the other hand) will, unfortunately, cripple growth. And (in such a case) policymakers would need to find alternative sources and much cheaper external finances for businesses and investments if they are to raise domestic rates.

Countries like Türkiye need higher growth, production (high value-added), employment and exports, more than stability! Therefore, Türkiye needs lower-cost finances. These financing needs and raised policy rates might also attract portfolio investments seeking arbitrage. Hot money or portfolio investments flee abroad at any time and usually lead to financial turmoil too.

As a contemporary example, Argentina has also raised its policy rate (to over 90% now) in the past few meetings. Though, it is still a mess. Türkiye, on the other hand, is a different story and needs to grow. Priorities and national dynamic differences matter.

Meanwhile, Türkiye also has a strong public budget. Fiscal discipline is achieved. Public finances are much healthier and more disciplined. Budget circumstances are not dire thanks to soaring tax collections (an over 100% increase).

A firm budget and low debt/growth domestic product (GDP) ratios provide notable room to maneuver for the Turkish economy and the government. The budget deficit-GDP ratio was 0.9% in 2022. The public debt-GDP ratio is much lower than its other emerging market or Organization for Economic Co-operation and Development (OECD) counterparts. The EU-defined public debt-GDP ratio is down to 30%.