As his country’s economic crisis deepens, largely because of his reckless policies, Turkish President Recep Tayyip Erdogan is flirting with Russian President Vladimir Putin and meddling in the Russo-Ukrainian war. He spent the week trying to raise his international stature, restoring diplomatic relations with Israel and participating in high-level talks in Lviv, which went nowhere. This is unlikely to end well for Erdogan in next year’s parliamentary elections.
With Turkey’s surprise 100 basis point interest rate cut on Thursday, one has to wonder if Erdogan fits the definition of insanity by doing the same thing over and over expecting a different result. Erdogan continues to pressure Turkey’s central bank to cut interest rates in order to rein in inflation, even as with each cut the Turkish lira falls to new lows and inflation soars to new highs.
The latest interest rate cut comes as Turkey’s inflation is nearly 80% and the lira has already lost a further 25% of its value this year. The country’s international reserves are depleted and investors are increasingly concerned about Turkey’s ability to meet its foreign debt obligation. This is reflected in a widening of Turkish credit default swaps at their highest level in the last 20 years and very high dollar lending rates for Turkey.
What makes Erdogan’s monetary policy even more difficult to understand is that it runs counter to basic economic theory and experience. If there is one thing almost all economists can agree on, it is that higher interest rates are needed to regain control over runaway inflation and a free-falling currency. This highlights how out of sync Erdogan’s monetary policy is with the ongoing interest rate tightening cycle in the rest of the world. Most of the world’s major central banks, notably the Federal Reserve, are raising interest rates to regain control of inflation.
Once again, by aggressively cutting interest rates at a time of already very high inflation and external economic weakness, Erdogan not only risks putting his country further down the path of hyperinflation; he also appears to be inviting a full-blown currency crisis by further incentivizing domestic residents to send their capital abroad. Such a crisis would make it very difficult for the country to meet its foreign debt obligations, which could require the imposition of economically damaging capital controls.
Increasing the risk of a currency crisis is the Federal Reserve’s interest rate hike cycle, which is causing a widespread repatriation of capital from emerging market economies. The same goes for Turkey’s huge external current account deficit, which has been negatively affected by rising international oil prices and the European economic slowdown.
If Erdogan’s reckless monetary policy doesn’t make economic sense, it doesn’t make political sense either. In June 2023, Erdogan will face the electorate in scheduled parliamentary elections. One would have thought that the last thing he would want is for voters to be mad at him because of runaway inflation and a collapsing economy. Yet that is what he is setting himself up for by following his highly idiosyncratic monetary policy.
Rudi Dornbusch, the late MIT economist, said that currency crises take much longer to happen than you might have thought. However, when they do occur, they do so at a much faster rate than you thought possible.
Erdogan would do well to heed Dornbusch’s warning and make an early U-turn in monetary policy to regain control over inflation. That way, he could save his country from another full-blown currency crisis in the run-up to next year’s elections.
It could also save us from a debt crisis in another midsize emerging market economy, which is the last thing an already challenged global economy needs.
If there is a silver lining to Turkey’s economic chaos, it is that Erdogan will likely be forced off the political stage after next year’s elections. If that happens, we might have a more reliable Turkish NATO partner to help us deal with Russia in its war with the Ukraine.
Desmond Lachman is a senior fellow at the American Enterprise Institute. He was deputy director of the Policy Review and Development Department at the International Monetary Fund and chief emerging markets economic strategist at Salomon Smith Barney.