Monday, November 1, 2010

Weekly Hurriyet Column: The garden of forking paths

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 media webeditor since March, you won't see much of a difference between the two.
I already explained in the article my inspiration for the title, so I can just right into more serious matters, i.e. my usual addendum:
First, as I promised when I posted the column to Facebook, let me briefly explain how I calculate potential output: I use a variety of non-Bayesian approaches, which are more less summarized in a recent IMF paper for Armenia. Of the methods outlined there, my favorite are the multivariate Kalman filter and production function, but the simplest is HP, which I provide below, courtesy of my friends at Turkey Data Monitor:
Anyway, the non-Bayesian methods have some important shortcomings, which are summarized in the same IMF paper, but Bayesian methods take much more time and since I am just lazy, I don't get into those. But suffice it to say that of I were calculating the output gap more professionally, I would have definitely come up with a Bayesian model.

Coming to policy response robust to consumer loans (the last paragraph of the column), although the CBT is sure to increase the reserve requirement further eventually, it was the government that struck first by raising the charge on consumer loans. Although the Resource Utilization Support Fund will be paid by the consumer, in practice, just like any tax hike, it will be absorbed by both the consumer and the producer (bank). I believe it will eat into bank profits as well because of competition in the banking sector.
Needless to say, I am surprised that I have been correctly guessing (well, sort of) government policy in advance for two consecutive weeks now, and my ego is sure to be inflated further as a result.

Now that I am done with the addenda, on to the column:

I could not have imagined a better description of the Central Bank of Turkey’s, or CBT, latest Business Tendency Survey, than the title of the Jorge Luis Borges story. The survey, which was released last Monday, paints a mixed picture of growth in October.

On one hand, capacity utilization rate, or CUR, at 75.3 percent, came in at higher than expected. While both the yearly and seasonally-adjusted monthly changes, at 7.1 and 1.4 percent, are strong, it is important to note that CUR used to hover around 80 percent before the crisis.
But it is also likely that there was some decline in capital stocks during the crisis. In that sense, there might not be as much slack in the economy. In any case, the CURs for the last two months hint at a low double-digit yearly growth in Industrial Production in September and a high single-digit one in October.
On the other hand, the real sector confidence index, or RSCI, continued with its downward creep, decreasing 3.5 points to 107.2. While the index is still comfortably above the 100 threshold separating economic expansion and contraction, it is at a nine-month low.
There are mixed signals coming from the sub-indices as well. While the new orders sub-component is now 23.3 points lower compared to five months earlier, appetite for investment expenditure looks solid, continuing to hover around 110 since the beginning of the year.

Interestingly enough, such a mixed picture seems to be behind the CBT’s growth forecasts in its latest Inflation Report, which was released Tuesday. The Bank does not actually reveal its growth forecasts. Instead, it makes its output gap projections public, which simply reveal how far the economy is expected to be from potential output.

Despite strong growth so far, the Bank is predicting a negative output gap through late next year. I would take its Research Department’s forecasts over mine any time, but by my account, the output gap has already closed. This is because I am assuming Turkey’s potential output has slightly fallen as a result of the crisis, but even with a very generous potential output estimate, such an enduring gap looks unlikely.

And history is on my side as well: The CBT’s model was also pointing to a negative output gap in 2005-2006 even though rapid credit growth, sticky service inflation and widening non-energy current account deficit were all ringing alarm bells. For example, the first Inflation Report of 2007 reported a negative gap of 2 percent for the last quarter of 2006.

Although overheating is inarguably not as drastic today, and the latest data discussed above do hint at a slowdown this quarter, other leading indicators are showing a strong third quarter growth outturn. It is too early to do an overall check-up of National Income Accounts, but existing data point to a strong consumption turnout.
For example, consumer confidence, actual consumption and consumer loans are all going very strong. The same could be said of investment, as machinery and equipment sub-index of Industrial Production, corporate loans and the RSCI sub-index for investment mentioned above are equally robust.
With import volumes increasing faster than export volumes, some leakage from external demand is to be expected. But I would nevertheless not be surprised to see a yearly growth of 6-6.5 percent in the third quarter. Then, according to my calculations, the output gap will have closed not only on a quarterly basis, but when measured as a four-quarter rolling sum as well.
Maybe, the CBT is foreseeing its exit strategy to curb loan growth. If not, inflationary pressures could start building soon. Then, we’ll see that even though some paths fork, all roads lead to Rome.

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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