Turkey's Risky Inflation Experiment
Turkish President Recep Tayyip Erdoğan insists that the country’s runaway inflation can be controlled by decreasing the nominal interest rate. But, given Turkey's current strategy for financing growth, there are clear reasons why eschewing economic orthodoxy will only wreak further havoc with prices.
WASHINGTON, DC – Monetary policy in most economies today is anchored by an explicit inflation target, because targeting price stability has served both developed countries and emerging markets well. Until pandemic-related disruptions to supply chains and labor markets began fueling rapid price growth, inflation was well below target in major economies, and, sooner or later, the question of what to do in such situations will return.
The twentieth-century American economist Irving Fisher had an answer. Economic orthodoxy dictates that central bankers should increase nominal interest rates when inflation exceeds policymakers’ target. After all, raising interest rates reduces borrowing and spending, cooling the economy and curbing inflation.
Fisher, however, argued that when inflation is too low, central banks should raise their targets for nominal interest rates. He maintained that there is a positive correlation between nominal interest rates and inflation. This relationship, known as the Fisher effect, can be seen in economic data. Modern macroeconomists interpret the causality as going from inflation to nominal interest rates.
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