Is the Central Bank’s rate hike sufficient, is the decision a U-turn?

The Central Bank increased the policy rate by 650 basis points at the first Monetary Policy Committee (PPK) meeting on June 22 under the leadership of the new chairman, Hafize Gaye Erkan. increased from 8.5 percent to 15 percent. With the regulations announced on Friday night following the decision, the pressures on the banking system were eased to some extent.

The resolution text of the MPC meeting announced on 22 June gives the impression that the old understanding has been thrown away, at least in principle. We see that the phrase “tight monetary policy”, which was once removed from the old texts one by one, re-enters the text.

In fact, it is clearly stated that “the Board decided to start the monetary tightening process in order to establish disinflation as soon as possible, to anchor inflation expectations, and to control the deterioration in pricing behavior” by going one step further, and clearly states that “in order to reduce inflation, it is necessary to increase interest rates”.

In this way, on June 14, President Recep Tayyip Erdogan reminded again “In order to reduce inflation, interest rates must fall.We observe that an understanding that contradicts the thesis ” but confirms the basic understanding of orthodox economics is defended.

In my previous article, the dove and the hawk about the decision of the Central Bank I mentioned two scenarios.

THE OLD UNDERSTANDING IS CLOCKED, TAKEN IN SIDE WAYS

The decision announced on June 22 is the most “pigeon“It was even below the rate hike. I interpret the interest rate increase to remain at such a low dose as a sharp break from the old understanding or as a side path at a point where the old understanding is blocked rather than a U-turn.

The lack of accounting for the old period,New Economy Model (SEM)The protection of the duties of MPC members, who have made aggressive interest rate cuts within the framework of ”, supports my opinion.

Keeping the rate increase low”gradual“Is it part of the upward trajectory or is it a sign that no further rate hikes are allowed?

I think the second possibility is high. Because the first interest rate hike had a symbolic importance in terms of the signal that the new team would open a clean page and that the step taken would be long-term.

Moreover, the fact that market interest rates had already reached 40 percent would have limited the tightening effects of the Central Bank’s decision in practice, and would have served to activate more expectation channels.

Isn’t an increase in interest rates, even if the amount is small, an improvement compared to YEM? Of course it is, and although it cannot correct the imbalances, it at least prevents it from deepening and provides a relative improvement. However, I think that an important opportunity has been wasted in terms of clues as to how long this improvement will last, and to what extent the deepening imbalances can be corrected with SEM.

FIGHTING INFLATION MAY NOT BE PRIORITY

If the aim of the new team is to take over the annual inflation from 40 percent and reduce it to the 5 percent target, they have a long and costly road ahead. Because the higher inflation rises and the longer it stays at those levels, the greater the painful recipe for lowering inflation expectations.

In this case, it is important to develop solutions that will minimize that cost and to use the communication policy effectively. My preference would be for front-loaded rate hikes to lower market expectations.

Especially at a point where the ammunition is limited and President Erdoğan does not give permission for an interest rate increase, a large interest rate increase that will come early can have a stronger psychological effect, lower the expectation faster, and in this way, less interest rate increases in the future. distance could be taken.

The fact that such a path has not been chosen may indicate that the fight against inflation is not a top priority, but rather a temporary program that will prevent a balance-of-payments crisis and provide some foreign currency inflow.

How does insufficient interest rate increase affect our lives?

Since an increase in interest rates is a “bitter prescription”, let’s first understand what will happen when we take this prescription and regain our health.

The ultimate goal of the bitter prescription is to prevent inflation-induced imbalances in the economy. In case of price stability, since the salary increases will be realized according to the predictable inflation rate, the meltdown in the purchasing power is prevented.

Since the depreciation of the exchange rate is also due to inflation, the exchange rate calms down. As the preservation of the value of TL will make TL-denominated savings instruments attractive, dollarization is prevented. When banks borrow long-term in TL, external debt decreases.

Investor confidence will be revived in an environment of price stability and financial stability, thus providing a suitable ground for investments that will increase production capacity and allow for increased productivity.

Now let’s focus on the low interest rate hikes, where this prescription is underdosed.

Medication given in insufficient doses does not provide treatment. It relieves the symptoms for a while. However, since the underlying problem continues, more serious treatment may be required afterwards.

Just as if you take an insufficient dose of antibiotics, you encounter more resistant bacteria and need a higher dose of medicine, the harder the inflation becomes, the more difficult it is to treat.

While slowing down interest rate increases does not provide the desired decrease in inflation expectations, on the other hand, the return to TL-denominated savings instruments is insufficient due to the current negative real interest rate environment. In this case, pressures on exchange rates and inflation continue.

In other words, the drug that is kept low today causes an increase in the dose of the bitter prescription that must be applied to ultimately reduce inflation.