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Turkey’s Macro View, Part 2: Source of Historical Inflation Problems and the Current Improving Inflationary Environment

Turkey’s Macro View, Part 2: Source of Historical Inflation Problems and the Current Improving Inflationary Environment
DECEMBER 21, 2010

Chart 1: Moving Averages for Turkish Money
Supply
 and Turkey’s CPI Index Changes

Turkey’s Central Bank monetary easing policy was the major source of the enormous growth in Turkish inflation, or increases in growth of Turkey’s CPI index. Best case-in-point can be found in the years 1994 to 1999 when Turkey’s Central Bank tried staving off recession, which came to fruition as negative real GDP growth rates in 1994 and 1999, -6% and -5% respectively. In both instances, Turkey’s Central Bank exponentially increased Turkish money supply, heavily depreciating the Turkish Liraagainst the US Dollar in an attempt to grow net exports and, implicitly, nominal and real output growth, which caused spikes in Turkey’s Consumer Price Index (NYSEARCA:CPI). Data from the past 35 years ofTurkish history reveal near perfectly positive correlation between Turkey’s Money Supply Year-Over-Year % Changes and Turkey’s Consumer Price Index (CPI) Year-Over-Year % Changes [Correlation Coefficient = +0.890]. Further, Turkey’s Central Bank tried so hard to prevent negative real output growth, that they abused monetary easing policy, resulting in colossal increases in the Turkish inflation rate [See Charts 1 and 2] and enlarging the government deficit as a ratio to GDP [See Chart 3].

Chart 2: Correlation between Turkish Money
Supply and Turkish Inflation Rate Changes

From 1994 to 1999, Turkey’s average inflation rate jumped to 85% per annum and totaled 510% for these years. Further, from 1981 to 2010, excluding 1994 to 1999, Turkey’s inflation rate averaged 39% per annum and totaled 971%, which says that in the 6 years, from 1994 to 1999, Turkey’s inflation rate increase made-up 53% of the total increase seen in the other 25 years of data. These data reaffirm that Turkey’s Central Bank was targeting Lira devaluation, in order to stave off recession in Turkey. From 1988 to 1994, the correlation between Turkish Lira/US Dollar exchange rate depreciation and money supply growth was almost perfectly negative [Correlation = -0.95], exhibiting a near 1% depreciation in the value of the Lira against the Dollar for every 1% increase in the money supply growth rate. When Turkey’s economy was in peril, from year-end 1993 through 1999, the money supply grew 8,048%.

Also, confirming that Turkey’s Central Bank used monetary easing to rescue and grow economic output in Turkey, from 1994 to 1997, Turkey’s money supply growth had a relatively positive correlation to increases in Turkey’s real GDP from 1995 to 1998 [Correlation = 0.56], along with a near perfect positive correlation to increases in nominal GDP [Correlation = 0.91]. Evidently, in this particular time period, Turkey’s Central Bank short-run and mid-run monetary policy was set to maintain positive nominal and real output growth amidst poor economic conditions in Turkey, knowing that money supply effects on real output growth could not extend beyond mid-run monetary policy. From 1981 to 2010, excluding recession years and the period from 1994 through 1999, Turkey’s Central Bank did not pump money supply into the economy with the purpose of bolstering Turkey’s real GDP growth [Correlation = 0.06], solely growing nominal output [Correlation = 0.77] but less so than during times of recession. The answer becomes clear that the source of inflation in Turkey’s history stems directly from Turkey’s Central Bank monetary policy, the worst of which emanated from compound effects brought on by the Central Bank’s decision to target large increases in both real and nominal output growth during recessionary periods.

Chart 3: Turkey’s Central Bank Monetary Policy and Resulting

Swings in Turkey’s Government Deficit as Ratio to GDP