Monday, May 3, 2010

Weekly Hurriyet Column: Rebel with a cause

Below is the unedited version of my column for this week. You can read the final version at the Daily News website, but since I have been editing my columns myself on the Daily News website since March, you won't see much of a difference between the two. As for cheesy references, I am sticking to movies with an oldie but goldie. All the other references are embedded as hyperlinks in the text, as I have started doing since I got the web-editing power of my columns, but I forgot the read my lips reference at the very end- the hyperlink has even an actual recording. By the way, the column it is a continuation of a Thursday post, so the credit column got dumped yet again:( The perils of writing once a week...

As for the column, an important point I had to leave out because of space constraints was the analysis of when the CBT should raise rates. Using a Taylor rule, I tried to justify the 4Q rate hikes with all the different parameters, and I couldn't, even with quite high output gaps. In most cases, I found that the Bank should have already started tightening in the last couple of months. But, this exercise is kind of pointless because as I explain in the column, the CBT sees inflation as temporary, so its actual inflation is not the inflation we are seeing. Of course, another explanation would be that the Bank has a third factor in its interest-setting equation, such as elections or the smile on the PM's face. Now, we are getting into dangerous territory:)...

Anyway, on to the column and by the way, apologies to Korean readers for my little pun, but it wasn't me who invented "come to Seoul to shake up your soul" or "Seoul, the soul of Asia"...

I always felt bad for being the sole soul outside Seoul confused by the Central Bank of Turkey, or CBT.

But for once, I feel comfort in the company of strangers: With more or less equally divided between labeling the Bank’s latest Inflation Report as hawkish or dovish, economists seem to be as baffled.

In fact, the Report has elements of both: While the Bank’s upwards revision of its year-end inflation forecast to 8.4 percent from 6.9 percent and its discussion of risks to its baseline inflation and policy outlook are definitely on the hawkish side of things, its commitment to hold rates until the last quarter and engage in limited hikes thereafter are definitely signs of dovishness.

The Bank has also been kind enough to share with us what led to the upward revision in this year’s inflation forecast: Higher energy and food prices (0.15 and 0.55 percent), larger-than-expected impact from the January tax measures and a narrower output gap (both 0.4 percent).

The latter reveals that a fast recovery is not in the Bank’s baseline scenario. And I would have concurred, were it not for recent data: April capacity utilization and real sector confidence, both from the CBT's monthly business tendency survey, came in quite strong last Monday. Although these figures have lifted the hopes of even a perennial pessimist like me, one month’s data is hardly enough to reach a firm conclusion.

But my work with Konda for their Barometer surveys, which I am not allowed to disclose, has led me to question one of the Central Bank’s key assumptions that, with unemployment expected to remain high, the recovery is not expected to be inflationary.

The contributions also build the case that the rise in inflation is due to temporary factors and therefore temporary. That’s how the Bank can justify its dovish policy rate stance and low inflation forecasts for the next two years: 5.4 and 5 percent for end-2011 and 2012 respectively, conveniently just below the Bank’s targets for both years.

Again, I am puzzled: With the output gap bound to close in that timeframe, the lira unlikely to appreciate in real terms significantly much more and barring any positive surprises on the supply-side, I cannot see how inflation will suddenly fall 3 percent next year rather than get stuck in the 7-8 percent range.

On the other hand, I am crystal clear on the Bank’s stance: With inflation expectations still untamed, the Bank has been forced to play the James Dean chicken game with the markets. As any student of Economics would know, that game has two pure strategy Nash equilibria, one which the markets cave in, and one which the CBT yields.

There is a also a mixed equilibrium, but it is way too early on Sunday, and without my morning cup of coffee, I am likely to get mixed up. As I am too lazy to open my favorite game theory book, you should consult the nearest theorist, but if you just are wondering the opinion of your friendly neighborhood economist, I am getting slightly more inclined towards the Bank swerving from the road.

As for the Bank’s attention to factors that could lead to earlier rate hikes, such as the rise in inflation expectations leading to deteriorating price-setting behavior, sharper-than-expected pick-up in global demand or commodity prices and loose fiscal policy, the CBT is simply executing deterrence theory, an artifact of the Cold War. Deterrence theory might have worked, but we could have easily ended up in the Dr. Strangelove world as well.

Turning to more recent history, my friends at Global Source titled their take on the Inflation Report “Read my lips: No Hikes until the fourth quarter”. I don’t know if it’s just me, but I suddenly remembered Papa-Bush talking about tax hikes.

Emre Deliveli is a freelance consultant and columnist for Hurriyet Daily News & Economic Review and Forbes as well as a contributor to Roubini Global Economics. Read his economics blog at

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