Inflation in Turkey is gaining momentum. The central bank is countering this with massive interest rate increases. The success is manageable.
Turkey cannot get the severe inflation under control. Although the central bank raised the key interest rate to a whopping 42.5 percent, the general price level rose by almost 65 percent in December. The inflation rate thus reached its highest level in just over a year. And now the next price surge is looming.
The reason is the surprisingly large increase in the minimum wage. Labor Minister Vedat Isikhan announced at the end of last year that the monthly minimum wage would rise to the equivalent of 520 euros in 2024. This represents an increase of 49 percent compared to the level set in July. Compared to January 2023, it has even doubled. Around seven million Turks will benefit from the higher wage floor.
The minimum wage in Turkey is usually adjusted once a year. However, due to high inflation and the weakness of the local currency, the lira, the government has increased it every six months for the past two years. The new increase will have a “significant impact on inflation,” the Reuters news agency quotes an economist who wishes to remain anonymous. The logic behind it: Companies try to cushion higher labor costs through higher prices.
“Prices will increase by at least 25 to 30 percent,” said Berke Icten, chairman of the Turkish Shoe Manufacturers Association. This will be reflected in retail prices. “A two-tier increase in the minimum wage would have been better for both employees and employers and would not have caused a sudden spike in inflation,” Icten said. The central bank is currently assuming that inflation will shoot up to 75 percent by May, thus reaching its new peak. The bank predicts a rate of 36 percent for the end of the year.
Edogan is “interest rate enemy”
After currency devaluation in Turkey reached values of over 80 percent in 2022, inflation fell noticeably over the past year. Inflation rates of under 40 percent were reached at times before inflation increased again since last summer.
The inflation problem in Turkey is largely of its own making: Until his re-election, President Recep Tayyip Erdogan had implemented a loose monetary policy at the – only formally independent – central bank, even though inflation threatened to get out of control.
Erdogan describes himself as an “enemy of interest rates”, sees interest rates as the “mother of all evils” and claims, contrary to past practical experience and economic theory, that low interest rates ensure low inflation and high interest rates ensure high inflation.
To enforce this unorthodox monetary policy, Erdogan fired several central bank chiefs and finance ministers until he found a central bank governor who would fulfill his desire for low interest rates. In between, the head of the statistics agency had to leave. Erdogan had accused him of exaggerating the extent of inflation.
Central banker moves in with her parents
The loose monetary policy fueled inflation and the currency crisis, but at the same time ensured economic growth – a key reason for Erdogan’s popularity among his voters. He bet that record inflation was temporary and merely collateral damage on the road to his re-election.
A few days after the start of his third term in office, Erdogan pulled the emergency monetary brake last summer and appointed Hafize Gaye Erkan as head of the central bank. She follows economic theory and raised the key interest rate from 8.5 percent to the current level. The logic behind it: If loans become more expensive, then this slows down both consumption and investments and thus demand. This tends to dampen prices. However, it will take some time for the interest rate increases to have their full effect. As a rule of thumb, the duration is between 12 and 18 months.
The central banker Erkan moved from New York to Istanbul to start her new job. Given the extremely high and rapidly rising rents in the metropolis with a population of millions, she lives with her parents. “We haven’t found any accommodation in Istanbul,” she recently told the newspaper Hurriyet. “It’s terribly expensive.”