The Turkish Overheating Debate

I don’t really  read all that many Turkey reports; I skim quite a few, but there are only a few guys I read regularly, with one of those being Yapi Kredi, or YKB, Research. I was surprised, although I am not sure pleasantly or not, to find that I have been quoted by them in their latest Weekly:

We had comments like the following in a highly reputable media source as well though with no analysis backing up the extremely assertive statements made: “We just confirmed that the economy grew really fast in the first quarter, although there is some disagreement on whether it has been overheating or not- with the Central Bank, supported by a few market economists, arguing that it is not, and the rest of the pack saying it is. I don’t know why, but somehow, this reminds me of the difference of opinion regarding the musical abilities of Cacofonix the Bard: He thinks he is a genius. The rest of the village contends he is unbearable.” We, needless to say, are among the few “no overheating” advocates. The problem with the intended analogy is the following: We may have been unbearable in our dogged request for credible feedback/criticism/response regarding our methodologies, but we are very well aware of the fact that we are far from being geniuses. We are mediocre minds with mediocre empirical skills trying only to follow theoretical advancement as best as we can.

The quote is from my recent post on first quarter GDP and May trade figures. It is good that they called RGE Economonitor “a reputable media source” (but not your friendly neighborhood economist), but they don’t seem too happy with my remarks, which have led me to explain myself.

First of all, my remarks were not intended for them, but for the Central Bank of Turkey and a couple of market economists who claim there is no overheating with data as equally flawed as those coming from the overheating camp, as explained in the Yapi Kredi weekly. I confirmed with one of the economists there what I already knew: That they don’t really say, despite what is noted in the quote above, that the economy has not overheated. They rather criticize the approach of the consensus, whereby most economists, including yours truly, are speaking as if they are 100 percent sure that there is overheating and use, according to YKB economists, flawed data/methods to support their claims. In fact, they have several really good research notes, where they show that the overheating camp’s methodology could be flawed. So I was/am surprised that they seemed to be offended by my comments.

But in retrospect, it seems that the Cacofonix example was, let’s say,  less than perfect: I don’t find the CBT unbearable at all. On the contrary, as I noted in last week’s column, I think very highly of their Research Department. But I also think that they are doing a horrible job at communication. Just yesterday, Governor Basci was again making statements on the decreased pricing power of firms without any solid proof. Now, they both have the data and human resources to back up their claims, so I really don’t understand why they are not doing so. Economists who are much more outspoken and skeptical of the CBT than me, such as my dear friend and abi Atilla Yesilada, claim that this is because they can’t, and that the CBT is not an independent institution anymore- BTW- Atilla once said that the CBT was suffering from mad cow disease, getting YKB’s arrows as a result. But I am sure they could do a better job supporting some of their claims, whether or not Atilla is right.

As for the overheating argument, after noting that they do not really defend no-overheating, just that they disprove overheating, the YKB economist made a very important point, with which I fully agree: There are much more demand-side indicators on the Turkish economy than supply side. As a result, you have a pretty good idea of demand, but not that of supply, and so overheating arguments/measures could be biased towards demand-side indicators. In fact, if you speak Turkish, they have summarized their points in a note published right after their weekly- contrary to some of their other stuff, it is 100 percent non-technical, so it is definitely worth a look.

My take on all this: I believe there is overheating in the economy, based on my good (or bad, time will tell) judgment and “flawed” metrics, but I also accept that there isn’t sure-evidence on both sides of the debate. And it is normal that there isn’t: Real life is much more complicated than that. But I would say that there are many indicators of overheating, as there are many of non-overheating. As much as the Economist’s methodology of overheating indicators in its latest issue, of which YKB economists are very critical, is flawed, so is jumping to conclusions on confidence indices, which are heavily influenced by asset prices- YKB economists are also very critical of graph-economics, i.e. using correlation to jump to conclusions on causality, but as I mention in that post, I did the official tests, at least once upon a time in a galaxy far away:) In sum, there is no perfect methodology, IMHO, that shows that the economy has overheated or not. To render unto YKB what is YKB’s, their own methods are much better than the competition’s, but they cannot give us a definite answer, either. That is the sad truth, even if you can switch Markov, Pavlov or my friend from grad. school Piankov:)

Besides, at the end of the day, it really doesn’t matter if the economy has/is overheated or not: As the YKB economist concurred, it is crazy to claim all is well, as PM Erdogan was doing during his new cabinet announcement, with these GDP and current account numbers. So overheating or not, if policy can’t induce a soft-landing, we’ll end up with a crash-landing. It matters what the problems are to recommend the appropriate remedies, but even without deep analysis, it is apparent that demand-restraining policies are needed, preferably with measures towards curbing private consumption.

Finally, since my Cacofonix the bard example seems to have been misplaced, let me substitute it with a story: Once upon a time, there was a wise king, who was loved by his subjects. One day, the river of the kingdom was put under a spell, by a (b/w)icth: Anyone who drank the water would become mad (not mad cow, just mad). The king tried to warn his subjects, but anyone who drank the water was telling his friends to drink from the river as well, so soon all the kingdom, except the king, turned mad. But then their wise king did not seem so wise any more: “Our king is crazy”, said a bard one day, and everyone agreed. So they overthrew the king and replaced him with his son the crown prince, who had also drunk from the river…

I am not making any comments on who the king and the subjects represents, as I do not want to feature in YKB’s next weekly as well:)…

Author: EMRE DELİVELİ
July 6th, 2011

SOURCE: ECONOMONITOR