The responsibility of these does not fall exclusively on the Central Bank. It would be extremely unfair to claim so; but so would to ignore the role of monetary policy in this picture.

Such comments are quite popular at news channels nowadays: “The Central Bank refrains from raising interest rates for such step might constrain growth.” This interest rate issue is getting increasingly interesting, so that we are almost going to divide into camps. The question is, whether or not the Central Bank can boost GDP growth by keeping interests rates low. Before answering this question, we have to think on another one: “Why doesn’t the Central Bank cut the interest rate down to zero for furthering GDP growth?” There are three versions of the answer here.

Actually the answer is quite clear: if you disturb the balances in one sector of the economy, it eventually spreads to the rest. This means, in a country like Turkey which has high current account deficit, interest rate should not be kept below inflation. Otherwise, you will discourage saving and encourage consumption. This might seem fine until the point current account deficit starts to climb. This means a higher net capital inflow (finance) requirement, which pushes up the international risk perception about Turkey. What is more, it poses large economics risks in the event of a domestic turmoil. Exchange and interest rate moves up. The deterioration of corporate sector balances due to the exchange rate hike on the one hand and the significant rise in interest rates on the other hand constrain GDP growth.

This can be read from an entirely different perspective: in a country where inflation rate stood at high rates over a long timeframe and is still high compared to rival economies, the anti-inflationary objectives cannot be achieved with interest rate standing below inflation. It might be that current level of inflation is not disturbing and reducing it is not the main objective. Such policy might be pursued to improve the competitiveness in export markets (by keeping exchange rate at low levels). But this soon pushes up costs due to the rise in inflation; exporters are forced to increase their prices, which would eventually damage international competitiveness. At the end of the day you would be left with nothing but high inflation.

Here is another version of the answer: “There is no value in excess. First set a reasonable level of real interest rate, and then decide whether to decrease or increase it or to keep it unchanged. First ensure that there is no difference between the interest rate and inflation that will disturb economic balances; then do whatever you like”.

Unfortunately, this was not the case in Turkey. The Central Bank’s policy rate (average funding rate) was 5.5 percent in May 2013, right before the well-known statements of Bernanke. Please note that back then, inflation rate was around 7 percent and the record-high current account, which deficit was eased only to 6.2 percent of the GDP despite a very weak GDP growth of 2.2 percent, started to climb again. Interest rate cannot be kept at this level under the current economic conditions. Otherwise, problems will burst in other sectors of the economy. For instance, in 2013, average inflation was 7.5 percent: problem number one. Current account deficit to GDP ratio for 2013 will be around 7.5 percent: problem number two. All international reports consider Turkey at the top on the list of countries that will be hit the hardest by monetary tightening measures of rich countries: problem number three.

Of course the responsibility of these does not fall exclusively on the Central Bank. It would be extremely unfair to claim so; but so would be to ignore the role of monetary policy in this picture.

This commentary was published in Radikal daily on 18.01.2014