It is hard to overcome the rigidity and Turkey generally was unable to overcome it. As a result, inflation rate commonly exceeded the target, damaging confidence.

The lowest year-end inflation rate since 2002 was recorded in 2012, at 6.2 percent. A few months ago everyone, the Central Bank (CB) to begin with, was pessimist about the inflation outlook. In a report dated 24 October for instance, the CB estimated that year-end inflation will float between 6.9 and 7.9 percent.

My optimistic observations about the inflation outlook end here, however. I would like to present two observations which are rather pessimistic.

Above the target

First, year-end inflation is 1.2 points above the target. Second, annual headline inflation (l index) that has been in decline for a long time now did not do so but increased slightly month-on-month.

The biggest danger concerning the inflationary outlook is different however: average inflation since the start of the explicit inflation targeting regime has been high. Year-end inflation is 8.2 and monthly inflation rate is 8.4, on average. If there were a constant upwards or downwards trend in inflation over this timeframe, average figures would be insignificant. Yet there wasn’t such trend; the rates fluctuated. For instance, the year-end rate was 6.5 in 2009, 6.4 in 2010 or was as low as 4.2 in February 2011. At the end of the day, however, the “low” levels were never stable.

What is more, this is not a new phenomenon for us. We were talking about this very problem two years ago: since the interval of fluctuation is narrow, inflation rate becomes rigid. And the ability to meet the inflation target depends on overcoming this rigidity.

It is hard to overcome the rigidity. Turkey generally was unable to overcome it, anyway. As a result, inflation rate commonly exceeded the target, damaging the confidence into the target per se. However, any monetary policy regime makes effort to minimize uncertainties so that economic actors, the actions of whom influence the economy, make decisions in a foreseeable atmosphere. A target set by the monetary authority reduces future uncertainties and makes planning easier, provided that the target it deemed reliable. The emerging rigidity in expected (year-end) inflation is worrisome from this perspective.

This outlook has two negative effects other than the fact that it makes monetary policy dysfunctional on one of its key objectives. First, it causes a competition disadvantage in export markets by raising production costs. The second point was raised during the presentation of the Central Bank governor on the 2013 monetary policy framework. The guest first stressed that the salary raises of public sector employees were adjusted to the inflation rate target and readjusted if inflation exceeded the target. Later he noted that most private sector companies also decided raises on the basis of inflation target while a similar readjustment was not made for salaries when realized inflation rate exceeds the target.  In other words, he emphasized that the inability to fulfill the inflation target harmed a large proportion of the labor force.

I guess this requires no further comment.

This commentary was published in Radikal daily on 05.01.2013