Prior to the 2001 crisis, Turkey was implementing a loose, fixed exchange rate regime that was essentially a version of a fixed exchange rate regime. Actually, as part of this exchange rate regime, the theory for which was contributed by Stanley Fischer, a former governor of the Bank of Israel, central banks were also targeting an implicit exchange rate for the sake of price stability to counteract inflation. This model, aiming to prevent inflation with high interests and valuable local currencies alone was undoubtedly a crisis-creating dynamic for a fully open economy.
When we look at all developing-country crises in the 1990s, and the crises of 1994 and 2001 in Turkey, we see two major fallacies from Fischer and the International Monetary Fund (IMF). First, in such countries, uncontrolled financial freedom was injected without establishing a free-market infrastructure, law and relevant regulatory institutions. Second, exchange rate regimes were designed as intermediate exchange regimes to kill the industry in these countries and condemn them to China, which functioned as the factory of the West. Throughout this period, while China kept the value of its currency low, other countries such as Turkey, Mexico, Argentina, Brazil and Russia, which followed Fischer and the IMF's guidebook, targeted valuable domestic currencies and kept interest rates high. Therefore, the economy of goods subjected to foreign trade failed to develop in these countries while countries like Russia, which has plenty of natural resources, tentatively handled the situation.
Following the 2001 crisis, Turkey adopted a floating exchange rate regime, but it did not actually practice it. It maintained implicit exchange rate targeting through a high interest instrument under inflation targeting, which gave rise to an economy with a danger of high current account deficits, production-supply-side inflation, high unemployment and stagnation.
In fact, it had come to light in the early 1960s that this theory was not applicable. Robert Mundell and Marcus Fleming carried out independent studies in the early 1960s in which they looked at how John Maynard Keynes's theory would work in countries that were fully open to capital movements. The key concept in their study was balance of payments, and the model that they put forth – the Mundell-Fleming model – can be practiced in open economies today. The model suggests an impossible trinity consisting of the alternatives of a stable foreign exchange rate, free capital movement (absence of capital controls) and independent monetary policy. Governments can implement just two out of these three options simultaneously. The essence of this trinity suggests that a country can achieve only two out of the following three objectives. The basic consequences of the trinity can be explained as follows.
In an economy where capital movements are free, a stable exchange rate can be ensured when a fixed exchange rate system is adopted. In this case, however, a country's central bank cannot change interest rates independently from interest rates in the world, which means that it is impossible for that country to pursue an independent monetary policy.
Although Turkey adopted a floating exchange rate regime after the 2001 crisis, it prevented the Central Bank of the Republic of Turkey (CRBT) from practicing independent monetary policy by implicitly targeting exchange rates. This being the case, the basic dynamic of a floating exchange rate regime did not work and the country was condemned to unhealthy capital inflows based on hot money. In this process, as in the fixed exchange rate regime, price stability was ensured through high interest rates and the automatic balance of money and capital markets was never achieved.
High interest rates also killed industry and employment-creating investments, paving the way for a consumption-wasting economy based on imports and borrowing, making inflation chronic on the supply side. This process also fostered a state of crisis along with high unemployment, leading to stagflation.
Recep Tayyip Erdoğan has always opposed this non-market and irrational situation both as prime minister and president. During a Justice and Development Party (AK Party) parliamentary group meeting on May 27, 2014, then Prime Minister Erdoğan chastised policies based on high interest rates that transferred funds to the outside and prevented growth, asking: "During World War II, Germany and Japan were destroyed. Although Turkey did not join this war, why did it lag so far behind these two countries that were destroyed in those years?" This question has multiple answers. However, I would like to ask another question. For instance, did Japan develop by keeping its local currency overvalued and through an interest rate that prevented its investments after 1947? It did just the opposite. The Japanese yen has always been competitive. Undoubtedly, Turkey and Japan have quite different economic dynamics. However, if a country has a fully open economy, it has to choose an independent monetary policy and a competitive local currency. Otherwise, it will stay away from global competition, cannot improve technological efficiency and cannot have comparative superiority in high value-added exportable commodities. Another name for this is underdevelopment.
Despite Erdoğan's repeated warnings and criticism, Turkey has not been able to overcome this mangle. The causes of this and those who are responsible are not the subject of this piece, but a subject of a much longer look.
Meanwhile, the growth in 2017 has given us a great opportunity to finish a period and this irrational situation. Erdoğan's statements on the economy ended a period for Turkey's economy. The period of debt and an import economy based on high interest rates is over.
A new growth model for a new industrial revolution has started. This high and inclusive growth model, which is based on industry and exports, coupled with low interest rates and realistic exchange rates, will attract foreign investment as direct investments rather than as hot money.
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