Background Information

Between 2021 and 2023, Turkey’s monetary policy underwent significant changes, largely driven by President Recep Tayyip Erdoğan’s unconventional economic views, which favored low interest rates to stimulate growth despite high inflation. The Central Bank of the Republic of Turkey (CBRT) followed this approach, resulting in a series of interest rate cuts even as inflation soared.

Economic Theory Behind the Policy and Intended Impact

The theoretical basis for Turkey’s low interest rate policy was to stimulate economic growth by reducing borrowing costs, thereby encouraging investment and consumption. Key components and intended impacts included:

Stimulating Economic Growth: Lower interest rates aimed to boost economic activity by making credit cheaper for businesses and consumers, thus encouraging spending and investment.

Supporting Employment: The policy intended to support job creation by fostering an environment conducive to business expansion and consumer spending.

Weakening the Lira: Lower interest rates were expected to weaken the Turkish lira, theoretically making exports more competitive and improving the trade balance.

Intended Impact: The primary goals were to achieve rapid economic growth, reduce unemployment, and stimulate domestic demand through lower borrowing costs.

Unintended Consequences and Evaluations of Effectiveness

While the policy aimed to boost economic growth, it led to several unintended consequences:

High Inflation: The persistent low interest rates contributed to runaway inflation, which peaked at over 80% in 2022. This severely eroded purchasing power and led to widespread economic instability.

Currency Depreciation: The Turkish lira depreciated significantly, losing over 50% of its value against the US dollar between 2021 and 2023. This exacerbated inflation by increasing the cost of imports.

Loss of Investor Confidence: The unorthodox monetary policy led to a loss of confidence among international investors, resulting in capital outflows and further pressure on the lira.

Evaluations of Effectiveness: The policy’s effectiveness in stimulating growth was undermined by its severe impact on inflation and currency stability. While it may have temporarily supported economic activity, the longer-term consequences included heightened economic volatility and financial instability. In mid-2023, the CBRT began reversing course by significantly raising interest rates to combat inflation and stabilize the lira.

In conclusion, Turkey’s monetary policy between 2021 and 2023 focused on maintaining low interest rates to stimulate growth. However, this approach led to severe inflation, currency depreciation, and loss of investor confidence, necessitating a policy reversal in 2023 to stabilize the economy.