Below is the unedited version of my column for this week. You can read the final version at Hurriyet's authors archive. I like to keep both versions available at my blog for personal reasons: My editors do a very good job in making the main points of the article stand out with a couple of cosmetic changes, so I just want to be able to go back to both versions as part of my crash course in journalistic writing.
The Central Bank of Turkey (CBT) managed to surpass the Fed in engineering the perfect surprise rate cut last week. The statement accompanying the rate decision leaves no doubt that the Bank’s focus has shifted from inflation to growth, but a closer look is called for.
Joining the global rate reduction bandwagon
It may be argued that the Fed’s strong move on Tuesday paved the way to preemptive action by the Turkish central bank. However, the CBT was not acting alone: Nearly a dozen central banks cut rates this past week. If anything, it seems that the CBT has a good nose for detecting global trends, as it showed in joining the global rate reduction bandwagon with its surprise rate cut in November. In fact, with more and more emerging markets enacting fiscal stimuli and cutting policy rates, developed and emerging markets’ policy responses during a crisis are finally looking much alike.
It is normal for developed countries to be running countercyclical monetary and fiscal policies, but lack of a strong fiscal hand and fear of depreciations, among other things, have prevented emerging markets to ease money and use fiscal stimuli during downturns. But contrary to earlier episodes, the current crisis has started in developed countries, and emerging markets are now in a much better position to undertake expansionary policies.
Turkey, however, decouples from the relatively more comfortable part of the emerging world in two important aspects: First, while running tight fiscal policies for the past few years, it is still not in an as comfy fiscal seat as some of the commodity exporters. Perhaps more importantly, the external financing gap and banks’ preference for liquidity could lead to a slowdown in the traditional monetary transmission mechanism, reducing the effectiveness of monetary policy. While a potential IMF agreement could partially solve this problem, it will at the same time undoubtedly limit the scope for fiscal policy.
Making sense of the Bank
To support its policy stance, the CBT has been emphasizing the weak demand, the growing output gap and the limited exchange rate pass-through. Moreover, in the current environment of deleveraging, it will be global risk aversion, not lower rates, that will drive foreigners away. However, the CBT is also grossly understating the risks to prices. Inflation in Turkey is still mainly a domestic phenomenon, with service inflation continuing to be sticky, and last month’s flat producer prices reading could as well be due to the plunging oil prices rather than the weakening exchange rate pass-through. In addition, disruptions to capital inflows and liquidity could magnify the second-round inflationary effects from a weaker lira, which is yet another risk the Bank chooses to downplay. It also makes sense for the Central Bank to try to make up for FX liquidity with lira liquidity, but even if this works, rising domestic liquidity could put further pressure on the currency and prices.
While I understand the rationale of the Bank and even sympathize with it, the CBT is increasingly reminding me of 007 at the poker table in Casino Royale: Extremely self-confident and willing to take excessive risk. It can be argued that you should be willing be reckless when you are fighting global recession or global terrorists, as sometimes that’s the only way to walk with the chips from the poker table. But you may also end up emptying your pockets, with the Bank’s two recent policy reversals (in 2006 and early this year) being cases in point.
The Central Bank of Turkey (CBT) managed to surpass the Fed in engineering the perfect surprise rate cut last week. The statement accompanying the rate decision leaves no doubt that the Bank’s focus has shifted from inflation to growth, but a closer look is called for.
Joining the global rate reduction bandwagon
It may be argued that the Fed’s strong move on Tuesday paved the way to preemptive action by the Turkish central bank. However, the CBT was not acting alone: Nearly a dozen central banks cut rates this past week. If anything, it seems that the CBT has a good nose for detecting global trends, as it showed in joining the global rate reduction bandwagon with its surprise rate cut in November. In fact, with more and more emerging markets enacting fiscal stimuli and cutting policy rates, developed and emerging markets’ policy responses during a crisis are finally looking much alike.
It is normal for developed countries to be running countercyclical monetary and fiscal policies, but lack of a strong fiscal hand and fear of depreciations, among other things, have prevented emerging markets to ease money and use fiscal stimuli during downturns. But contrary to earlier episodes, the current crisis has started in developed countries, and emerging markets are now in a much better position to undertake expansionary policies.
Turkey, however, decouples from the relatively more comfortable part of the emerging world in two important aspects: First, while running tight fiscal policies for the past few years, it is still not in an as comfy fiscal seat as some of the commodity exporters. Perhaps more importantly, the external financing gap and banks’ preference for liquidity could lead to a slowdown in the traditional monetary transmission mechanism, reducing the effectiveness of monetary policy. While a potential IMF agreement could partially solve this problem, it will at the same time undoubtedly limit the scope for fiscal policy.
Making sense of the Bank
To support its policy stance, the CBT has been emphasizing the weak demand, the growing output gap and the limited exchange rate pass-through. Moreover, in the current environment of deleveraging, it will be global risk aversion, not lower rates, that will drive foreigners away. However, the CBT is also grossly understating the risks to prices. Inflation in Turkey is still mainly a domestic phenomenon, with service inflation continuing to be sticky, and last month’s flat producer prices reading could as well be due to the plunging oil prices rather than the weakening exchange rate pass-through. In addition, disruptions to capital inflows and liquidity could magnify the second-round inflationary effects from a weaker lira, which is yet another risk the Bank chooses to downplay. It also makes sense for the Central Bank to try to make up for FX liquidity with lira liquidity, but even if this works, rising domestic liquidity could put further pressure on the currency and prices.
While I understand the rationale of the Bank and even sympathize with it, the CBT is increasingly reminding me of 007 at the poker table in Casino Royale: Extremely self-confident and willing to take excessive risk. It can be argued that you should be willing be reckless when you are fighting global recession or global terrorists, as sometimes that’s the only way to walk with the chips from the poker table. But you may also end up emptying your pockets, with the Bank’s two recent policy reversals (in 2006 and early this year) being cases in point.
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