Bitcoin downside capture

What’s happening in monetary policy and macroeconomics. In most respects, President Erdogan of Turkey is not known for his progressive instincts, but in economic bitcoin downside capture he may be the only convinced Neo-Fisherite on the planet who potentially has any power over monetary policy decisions. Erdogan’s views have been derided by market participants, and some panic ensued, manifested in a depreciation in the Turkish currency. But, apparently Erdogan’s ideas aren’t coming out of thin air, as his economic advisor Cemil Ertem has written a defense of Erdogan’s views, which does a good job of finding the relevant supporting evidence.

So, what’s been going on in Turkey? Since 2004, inflation has been much lower than over the previous 20 years, and much more stable. What has the Turkish central bank been doing, and what does it propose to do in an attempt to hit its inflation target? In contrast to that optimistic forecast, inflation went up, not down, in the intervening period, and is currently well outside what was denoted the “forecast range” in the 2016 forecast. So, you might conclude that the Turkish central bank is not capable of reducing inflation. Well, what did the central bank do to produce the 2002-2004 disinflation?

Let’s look at the path for short-term interest rates and inflation over the same period as in the first chart. So, in that chart we’re seeing a typical Fisher effect – higher inflation is associated with higher nominal interest rates. The spikes in the overnight rate occurred during 1994 and 2001 financial crises in Turkey. As we all know, if central banks can do nothing else, they are at least capable of pegging short-term interest rates. So, the path we see in the above chart for the overnight rate was determined by the central bank of Turkey. Did the central bank engineer a disinflation by keeping the nominal interest rate high?

Monetary policy acted to reduce short-term nominal interest rates, and the inflation rate fell. I’d say President Erdogan isn’t as nutty as people are making him out to be – at least in the inflation policy realm. And Turkey is a very interesting example, as it appears to be following the orthodox central banking rulebook: Phillips curve, Taylor rule. There’s a lesson here for countries like Canada and the United States, where central bankers are currently hitting their inflation targets. But interest rate hikes can be overdone – the risk as that you become Turkey.