In a bold move intended to quell rampant inflation and price instability, Turkey’s central bank has upped its key interest rate by 5 percentage points. This significant increase, while anticipated, underscores President Recep Tayyip Erdogan’s ongoing shift toward more conventional economic strategies, a dramatic departure from his previous stance that lower interest rates would effectively combat inflation – a theory that contradicts established economic wisdom.

This decision propels Turkey towards a more orthodox economic approach, following severe criticism over Erdogan’s series of rate cuts which reportedly exacerbated the cost-of-living crisis for Turkish households. Now, with inflation rates soaring beyond expectations to a staggering 58.94% last month, Erdogan’s newly appointed economic team, which includes former Merrill Lynch banker Mehmet Simsek, have their work cut out for them as they strive to bring Turkey’s economy back on track.

Turkey’s Central Bank Hikes Key Interest Rate Amid Inflation Concerns

Turkey’s central bank has announced a significant hike of 5 percentage points in its key interest rate, taking it to a substantial 30%. This move is a part of the monetary tightening process to combat rising inflation and control price instability. The inflation rates for July and August went beyond expectations, with a peak of 58.94% last month.

A Shift towards Traditional Economic Policies

The interest rate hike signifies a shift towards more traditional economic policies under President Recep Tayyip Erdogan. Earlier, he faced criticism for a series of rate cuts, which allegedly exacerbated the cost of living crisis as inflation soared. Households in Turkey were left struggling with skyrocketing rents and the increased cost of basic goods.

Erdogan has always maintained that lower interest rates can combat inflation, a theory that contradicts conventional economic wisdom. The central bank, under Erdogan’s pressure, began cutting rates in late 2021.

Global Central Banks and Interest Rate Hikes

Simultaneously, central banks worldwide have been raising rates to control the rise in consumer prices in the aftermath of the COVID-19 pandemic and Russia’s war in Ukraine. Banks like the U.S. Federal Reserve and the Bank of England are now pausing as they near the end of their aggressive rate increases. Turkey, however, still has a considerable battle to fight against inflation.

Conversely, Erdogan, having won re-election in May, signaled a return to more conventional policies by appointing a new economic team. The team includes former Merrill Lynch banker Mehmet Simsek as finance minister, a position he held until 2018, and Hafize Gaye Erkan as the new central bank governor.

The Role of Erdogan’s Economic Policies

Before their appointments, the central bank had reduced its key interest rate from approximately 19% in 2021 to 8.5% earlier this year. Erdogan had previously dismissed three central bank governors who resisted rate cuts before appointing Erkan’s predecessor in 2021.

Economists argue that Erdogan’s unconventional policies have intensified economic turmoil, leading to currency and cost-of-living crises that have severely impacted households. Erdogan, however, insists that his economic model stimulates growth, exports, and employment.

Since Erkan’s appointment, the bank has raised its key rate several times: by an aggressive 7.5 percentage points in August, 2.5 percentage points in July, and 6.5 percentage points in June.

The Impact on the Turkish Lira

The Turkish lira, which has lost around 30% of its value against the U.S. dollar since the beginning of the year, dropped slightly against the greenback on Thursday.

Key Takeaways

The move towards more traditional economic policies by Turkey’s central bank is a welcome change, considering the previous unconventional policies that had led to economic turmoil. The aggressive hikes in the interest rate could potentially help control the rampant inflation and stabilize the economy. However, it’s essential to monitor the impact of these changes on the Turkish lira and the overall economic health of the country. The road to economic recovery might still be a long one for Turkey, but these measures indicate a step in the right direction.