How does Turkey approach the matter of interest?

The Dutch elections, as can be seen, did not result in the defeat of the neo-Nazis. As the center-right parties in the Netherlands switched to a neo-Nazi line, the neo-Nazi party lost votes. I will discuss this issue in the next article.

Today, I want to touch on a false debate over the U.S. Federal Reserve (Fed), which raised interest rates on Wednesday. It is obvious that this timid interest rate hike is only a pretended step. Developing countries no longer steer their monetary policies by looking to the Fed.

Unlike previously, developing countries are now creating new economic policies and related instruments that will overcome the high dollar syndrome. Why should the central bank of a developing country raise interest rates because the Fed has raised interest rates? The simple assumption behind this is that the Fed's interest rate hike directs the dollar to the U.S. in order to increase the dollar demand and price. In this case, central banks that do not have reserve currencies and that run external deficits increase interest rates and demand the dollar-based hot money through high interest rates.

Thus, they create a new balance in their domestic markets by looking to the Fed. But this is a vicious cycle. The hot money that inflows depending on high interest rates leads to a temporary appreciation in the local currency or prevents its depreciation against the dollar. This is actually a morphine effect. Unnecessarily high interest rates further tighten the domestic market, and increase the possibility of economic shrinkage. Apart from that, as the assumption requires, if the local currency becomes unnecessarily valuable with the inflow of hot money due to the rising interest rates, exports become disadvantageous for exchange rates. Therefore, economic growth falls into a problematic situation both in terms of domestic and foreign demand, and the two basic pillars of growth become paralyzed.

Meanwhile, for those who want a local currency with a stable and real value, let me note: A country's currency gains value in two ways against the basic reserve currencies (dollar and euro), but it can become strong and stable in a single way: Hot money inflows depending on high interest lead to a temporary appreciation in the local currency or stop its depreciation, but after a while, the local currency undergoes very high depreciation as domestic and foreign price balance is disturbed; foreign demand (export) becomes slower than domestic demand; and economy comes to experience unemployment and inflation (stagflation) at the same time.

However, the only way of making the local currency strong and stable is to support production and exports with a balanced exchange rate and interest rate policy (that is, to leave both variables to the market and to control the inflation and foreign capital inflows with interest rates in a floating exchange rate regime) and to attract foreign currency to the country in this way. So, if you support production, exports and inclusive growth, then you will truly maintain the value of the local currency.

In fact, Turkey did quite the opposite within the framework of economic policies imposed by the West. Trying to ensure balance and to control the inflation and exchange rates by basing interest rates on the inflation alone and correlating them with a simple arithmetic calculation means ruining the economy in the medium term.

Now, some ask why the Central Bank of the Republic of Turkey (CRBT) is keeping its policy interest rate stable. I think they should look at average industry profitability in Turkey. Profitability cannot be below interest rates.

Policy interest rate is a compass given to the market by central banks. Technically, this shows with what interest rate central banks will fund the banking system through repo on average. However, the CBRT has been funding the banking system with different instruments at a higher interest rate for a while. Still, this is a temporary state. This is because central banks indicate the interest rate that is required in an economy with the policy interest. This ratio is also the optimal, expected interest rate that protects or increases employment and controls the inflation and ensures price stability in this way. Based on this, I must note that we cannot find the required interest rate in a country based solely on the expected inflation. In fact, this is a very wrong and one-sided point of view.

Swedish economist Knut Wicksell describes the rate of return on an investment as a natural rate, and says that if the natural rate is above the borrowing cost (interest rate), the economy will run, otherwise stagnation will be inevitable.

On the other hand, however, there are innumerable contradictions of the traditional economic theory that apply to us. For instance, the Fisher equation, one of the most basic equations in macroeconomics, shows that the nominal interest rate is the sum of the real interest rate and the inflation expectation. In fact, both the Keynesian and the neoclassical approaches accept this theory, but the current monetary policies are trying to do the exact opposite of this equation. In other words, while the relation between interest rates and inflation are directly proportional to each other in the Fisher equitation, the monetary policies of developing countries were built in an inversely proportional way. It means that if the interest rate increases, the inflation will decrease or vice versa. Has this worked? In other words, could the central bank achieve its inflation target by continuously increasing interest rates? No! However, the rigidity we have in unemployment is the result of this policy.

Therefore, let us not discuss the economy through the interest rates today. Turkey's economy is on the right path. New institutions and practices such as the Credit Guarantee Fund and the Sovereign Wealth Fund are the first steps in the new era that support growth and employment. Turkey will continue to take such steps.