Turkey's government is ignoring economic orthodoxy and cutting interest rates while prices are rising.
Countries all around the world are currently dealing with record-busting inflation (price rises). But some places have it worse than others. Take Turkey. Its inflation rate is currently hovering around 80 percent, compared to the UK’s 10 percent in August 2022.
To put that another way, everytime they hit the shops Turks are having to shell out almost double what they would have paid for the same stuff a year ago. And despite the government upping the minimum wage twice in six months, average wages have not increased by anywhere near the same amount. The end result is that most of the population has become a lot poorer. Four-fifths of Turks now say they can barely afford their basic needs, such as food and rent. One third say they flat out can’t afford them.
Something that is unusual about Turkey’s inflation situation is how the country is trying to quash it. The Turkish Central Bank has repeatedly cut interest rates, aka the fee to borrow money and which is paid on savings. This policy flies in the face of mainstream economic theory, which states that the way to bring down inflation is to increase interest rates. That's why most countries are acting like the UK, where the Bank of England upped the interest rate in both June and August 2022. (While there are other proposed solutions for reducing inflation and its impacts floating about, such as making changes to government spending, pretty much everyone is on board with the idea that cutting interest rates will make inflation worse.)
Interest and inflation rates are seen as inversely correlated because of the effect interest is thought to have on economic activity. The argument goes like this: the higher the interest rate, the more expensive it is to borrow money, and therefore the less people and businesses will borrow. Similarly, the higher the interest rate, the more financially rewarding it is to save money, so the more people and businesses will save.
Less borrowing and more saving equals less spending on stuff, or, to put it in economic-speak, reduced demand for goods and services. And its demand that fuels inflation. The more people want something, the more money they will be willing to part with to get it, and the more other people there are that want that same thing, the more money they’ll probably have to part with to get it because sellers will generally set their price at the highest level they can. But if demand drops, prices should too.
The main reason Turkey is ignoring this theory is because its strongman President, Recep Tayyip Erdogan, believes it is wrong, although he has not been super forthcoming about why he thinks higher interest rates cause inflation. Some people think his interest-rate-slashing stance can be best explained by a statement he made in late 2021 about how he has to follow Islamic teachings. Islam forbids Muslims from charging or receiving interest, because of its belief that taking money off someone as part of a financial transaction is unjust and promotes inequality. In other words, perhaps the policy is less to do with altering inflation and more to do with Erdogan's push to make Turkey more religious.
Not everyone buys that theory. Some think Erdogan’s decision is less to do with Islam and more to do with the idea that lower interest rates stimulate economic growth (the increase in how much value is being created), which means more Turkish products, more Turkish jobs etc. This link between low interest rates and more growth is one that the economic profession does agree with, and indeed the Turkish economy grew by 11 percent in 2021. The problem, most economists would argue, is that high inflation will erode most of the benefits that economic growth can bring. After all, it’s not much use having lots more stuff about if nobody can afford to buy it.
Read our explainer on: inflation
