Published On: Mon, Oct 8th, 2018

Can increase in interest rates control exchange rates to end inflation expectations?


Turkey’s Central Bank had to implement high interest rate. According to the recently announced expectation survey of the Central Bank, the 2018 year-end inflation expectations of the respondents were 19.61 percent. Those who took part in this survey took decisions or made recommendations to decision-makers. Therefore, said expectations normally reflected what will happen to a large extent. At that stage, the Central Bank had to put an end to said negative expectations.

Actually the Central Bank had attempted ways other than increasing interest rate up to that stage and failed to break the expectations and thus increased the interest rate as it saw that there was no other solution applicable at the time. Therefore, the step taken was accurate – although quite late.

On the other hand the Central Bank has not been able to meet its inflation target for many years, and diverted from the target in the last two years, in specific. Also the reality is rather than the Central Bank following a policy the inflation is following the currency rates. Under said circumstances the Central Bank certainly needed to raise interest rates to keep inflation under control.

Some people cannot help asking “Why was the interest rate increase not made at the previous meeting? Did they not see the situation was going there? Because instead of accumulating so much trouble, if a 2-point rate increase had been made in the previous meeting, there would have probably been no need for such a dramatic increase in the last meeting.

The question at this point is “Will increasing the interest rate solve the problem and put an end to high inflation expectations”.

The answer to this question could be positive for the short term. On the other hand, changing the expectations in the medium to long term can be achieved by tightening the fiscal policy as well and not only the monetary policy. This shows the necessity for the tightening in monetary policy to be accompanied by tightening in fiscal policy.

The way to make this happen is to quit all projects with high costs to increase spending.

Because if interest rate is pulled up to 24 percent on one hand and the projects with high costs are not cancelled on the other hand, the market could require another demand for increase in interest rates.

Only then could the tough measure to be taken by the administration could have a chance to pay off to bring the economy to a controllable point again.

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