Difficult days for central banks

Published 19.07.2019 20:37
Updated 21.07.2019 00:28

While the world economy is in the grip of global trade wars, we have witnessed a general lack of appetite in real sector investments, especially in the machinery industry and sectors focused on investment goods. This picture also reduced the risk of inflation on a global scale. Global commodity prices have not exhibited inflationary risks. Thus, the world's leading central banks are in a loose or expansionary monetary policy stance because the risk of inflation has considerably decreased and the risk of stagnation has increased.

Central banks followed an explosive approach during the 2008 global financial crisis with radical expansionary monetary policies and now prefer to protect their economies from the risk of global stagnation with low caliber monetary policy weapons rather than powerful weapons that have limited influence, such as limited interest rate cuts or limited monetary expansion measures. Measures such as overdraft bond purchase programs and/or high cuts in interest rates that may cause a "bazooka" effect are being avoided due to the risk of sudden inflation.

U.S. Federal Reserve (Fed) President Jerome Powell's statements last Wednesday suggested the possibility of a decision to cut interest rates during the Fed's Federal Open Market Committee (FOMC) meeting next week; however, the biggest concern of the heads of central banks is the liquidity trap.

Put simply, it is the risk that expansionary monetary policy measures, as shortcuts, do not have the expected impact on savings holders via interest rate cuts, economic actors and consumers. Therefore, with the possibility that radical expansionary monetary policy measures may not cause the macroeconomic response to the extent expected, no one wants to stick their neck out.

Since measures to stimulate consumption in developed economies are less effective due to the digitalization of the financial system, the use of virtual money, the spread of digital money transfers and rapidly aging populations, central banks are increasingly worried whether they can steer their economies through monetary policy measures. No central bank, despite measures taken, wants their economies to enter a zero-growth spiral, nor do they want the same measures to allow inflation to get out of control. Leading central banks have reduced their interest rates 700 times in the last 10 years; however, concern over the effectiveness of monetary policy is growing day by day. Let's see what happens next week.

Lower interest rates needed

The Fed's own regulations clearly mention looking out for growth and employment. With the amendment made in the Central Bank of the Republic of Turkey's (CBRT) Law in 2001, we added a statement that mentions that, as long as it doesn't clash with price stability, the government should support growth and employment policies. Essentially, that was a must because it is not possible to separate price stability and financial stability in the 21st century. Financial stability means the economy's investment involves the savings balance on one side and the foreign exchange earnings-expenditure balance of the country on the other. Therefore, the CBRT's monetary policy also needs to direct sufficient savings toward the financial system and must have an additional aspect to enable the savings to turn into investments.

On the other hand, the monetary policy set must also drive the country's economy to a current account balance to a sustainable currency balance and exchange rate level. Success in financial stability, undoubtedly, also contributes to price stability, which is the main task of the central bank. At this point, it is necessary to clearly emphasize that the set of monetary policies formed under the pressure of demand inflation differs from the set of monetary policies formed under cost inflation. Economists criticizing the comments and calls from the government on the central bank's monetary policy, strangely, make their evaluations as if the Turkish economy was under pressure from demand inflation.

However, Turkey is actually experiencing pressure from cost inflation, and the high interest rate negates the effect of cost inflation. To get the economy out of cost inflation's effect, it is necessary to recover, revive and accelerate investments and balance oversaving. Therefore, the CBRT should rapidly analyze its inflation predictions for the next six months, nine months and one year, and without delay, lighten the cost effect caused by high interest rates. Between January 2017 and November 2018, the exchange rate jump was a risk for our economy. Today, on the other hand, the high interest rate is the risk. Hopefully, we will achieve a sensible mindset.

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