Monday, December 29, 2008

Weekly Hurriyet Daily News Column: The humbling of the economist

Below is the unedited version of my column for this week. You can read the final version at Hurriyet's authors archive. In addition, I would like to add in two clarifications: First, there was a small minority of economists who correctly forecasted the crisis, with the most notable exception being NYU Economics professor Nouriel Roubini, a.k.a. Dr. Doom, who has correctly predicted four of the last two crises. Second, while Bagehot's conservative central banker is a thing of the past, many of his principles do remain, so my apologies if I did injustice to the great Lombard Street. For one thing, central bankers today have well-trimmed facial hair (e.g. US and Turkey) just like in Bagehot's day.

In the last column of the year, it would be appropriate to summarize the major events and themes of 2008 in the Turkish economy, starting with a global detour to provide the background.

Major global themes

One major theme of 2008 across the world has been the humbling of the economist: Until as late as the Lehman collapse, many economists did not believe that the U.S. was experiencing its worst financial crisis since the Great Depression. Along with the U.S. financial crisis came a global slowdown.

Monetary policy response in the U.S. was swift, as the Fed became the lender of last resort for the world, while at the same time throwing anything short of the kitchen sink to get credit markets working again, and turning itself, in effect, into the world’s largest hedge fund in the process- the change in the size and composition in the Fed’s balance sheet is one of the big tales of the year. Other central banks were quick to follow in Fed’s footsteps and join the easing bandwagon towards year-end. In effect, gone is Walter Bagehot’s conservative central banker in Lombard Street, replaced by the desire to minimize tail risks. We have also seen the rebirth of Keynesian policies, as many countries have enacted fiscal stimulus packages. Having noticed the extent of the growth pullback, even the IMF Is not Mostly Fiscal anymore, as the Fund has been increasingly supportive of fiscal policy.

In a similar fashion, the roller coaster ride in oil prices was totally unexpected; to see this, just look at forecasts at the end of 2007 and mid-year. Finally, 2008 witnessed the great capital plight: The inflows to emerging markets during the liquidity glut years were sharply reversed, which, combined with volatility, uncertainty, risk aversion and deleveraging, brought down high carry currencies like the lira, where the consensus view early in the year was that USDTRY was on its way to parity.

The Turkish economy in 2008

The Turkish economy had already entered a downward trend when it was faced with the global picture outlined above, with growth figures until the end of the third quarter, contrary to the consensus view, relatively unscathed by the crisis. In fact, the most puzzling aspect of the great Turkish slowdown so far has been the trigger-happiness of the economy. Producers and consumers alike have sharply pulled back during the second half of the year, much more than economic theory (or empirics) can count for. Obviously, all the political bickering has not helped, either. Unfortunately, preliminary indicators hint that the global developments have started to take their toll on the economy through trade and financing channels in the last quarter, so expect the growth picture to turn ugly.

On the policy side, the unexpected hike in oil prices led the Central Bank of Turkey (CBT) to reverse its premature easing mid-year, as the impact on inflation became apparent. To its credit, the CBT realized the worsening inflation outlook earlier than markets, but the Bank still had to revise its inflation targets. Recently, the CBT has initiated a strong easing cycle, encouraged by the favorable domestic and global headwinds for monetary policy. However, the CBT is taking more risk than the Fed and other central banks going down the same path, as we close the year with a challenging and uncertain inflation outlook.

In fact, 2009 brings a great deal of uncertainty, not only globally but also for Turkey. This will be a good place to kick off the new year next week.

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