Interview: Expansionary fiscal policy may be limited due to snap polls
If we keep pushing this economy, which is already overheating, eventually what will happen is you will have to borrow more in order to grow more. If you borrow more, the Turkish lira will depreciate more.
Selva Demiralp, a well-respected economist, scholar and columnist in Turkey, has given an interview to Hurriyet Daily News. Below we share her comments on the recent developments in the Turkish economy, snap polls set for June 24, the controversial Turkish monetary policy and the AKP’s management of the economy.
Turkey has always prioritized growth to other macroeconomic objectives, but as growth is becoming costlier, the government has compromised on budget discipline by introducing a 6 billion dollar incentive package, according to economist Selva Demiralp. Snap elections could be a blessing, as they will shorten the duration of such expansionary policies, said Demiralp from Koç University.
What do snap elections mean for the Turkish economy?
Before each election, there is an expansionary fiscal policy that is somewhat unavoidable. In that sense, I view snap elections as a positive sign because the duration of expansionary fiscal policy will be shorter.
We have already seen signs of overheating since the beginning of 2017. For an economy that is already producing beyond its potential, if you further implement expansionary fiscal policy, this will take you further away from where you are supposed to be. When we look to the consequences, it generates growth in the short term and everyone likes growth, but it comes at a cost.
Based on the original scenario, elections would be held in November 2019, which pretty much meant we would have seen expansionary fiscal policy until then. For this particular period, the fact that the pre-election period is short—only two months—is an advantage.
Until recently, the Justice and Development Party (AKP) received credit for maintaining tight fiscal policies, especially during electoral campaigns. The fact that the government has disclosed a 6 billion dollar incentive package right before elections seems to show they have abandoned their initial approach.
If you look at the last 10 to 12 years since 2006, we see Turkey has always prioritized growth to other macroeconomic objectives. Before the United States Federal Reserve started tightening monetary policy, it was easier to generate growth in emerging market economies. Now, since the Fed has started tightening monetary policy, borrowing from the rest of the world has become costlier.
The AKP needs this extra push to generate growth. At that point, we see that the budget discipline, which was always a plus for the AKP, has started to weaken. This year, we thought there would be a 2 percent deficit to GDP ratio, whereas for the last 10 years, it was about 1 percent.
Many speculate the reason behind early elections is the deterioration of the economy.
When you look at the macroeconomic balances, we see signs of deterioration. The inflation rate is now settled at two digits and expectations indicate it is not to return to single digits anytime soon. Meanwhile, the current account deficit is increasing, because Turkey’s growth structure depends on imported intermediate goods and when the cost of importing becomes more expensive, the current account deficit to GDP ratio increases. The exchange rate was not going to be any better.
What do you expect after elections? Will there be a shift to tight fiscal policies?
An economy cannot grow beyond its potential output indefinitely. Sooner or later you will have to come back to your potential output. Is it going to be a soft landing or a hard landing? If you design your policies properly, if you do not wait for the inflation to go too high, and if you do not let the Turkish lira to depreciate too much, it could be a softer landing.
But as we have seen in the S&P’s recent decision, the reason they said they downgraded was because of concerns of a hard landing. Why are they concerned? If we keep pushing this economy, which is already overheating, eventually what will happen is you will have to borrow more in order to grow more. If you borrow more, the Turkish lira will depreciate more.
At some point, if this generates financial instability so that the Central Bank is worried about a financial crisis, then they will have to raise interest very sharply. If you raise interest rates sharply, then that will be the very first steps for a hard landing. So a slowdown is inevitable. That is basic Econ 101 material. You cannot produce beyond your potential indefinitely.
The government seems to believe a slowdown can trigger a recession.
That is how things started after the coup attempt. Uncertainty generated a slowdown. At that point, expansionary fiscal policy was justifiable because we think Turkey’s potential growth rate is around 5.5 percent. If you go below 5.5, then by all means, go ahead and increase the growth rate to 5.5. At that time, when the government stepped on the gas pedal, no one said anything.
It seems that policy paid off.
But it did too much. The government stepped on the gas, but they did not know when to hit the breaks. The economic growth did not stay at 5.5. We have seen it at 12 percent. Foreign institutions and rating agencies are concerned about an economy that is overheating.
But there is loss of confidence in these institutions.
These institutions lost a lot of credibility during the financial crisis. Yes, they can be subjective and there could be a political aspect. However, when you look at the factors they list, like Turkey’s high inflation rate, high current account deficit, higher budget deficit, the fact is we borrowed too much during the financial crisis when credit was cheap. We most likely could not utilize this debt in the most productive area since we are not producing enough to pay off that debt.
How do you think the Central Bank has been faring with the problem of inflation?
We have explicity been targeting inflation since 2006. It has been 12 years. Aside from two years, Turkey has never been able to hit its target inflation. Clearly, monetary policy has never been tight enough to reach the target. Nowadays, we are actually seeing a further deterioration of the inflation rate. Previously, our target was five but the actual rate was around 7 or 8 percent. Now, the target is still five and the actual inflation rate is around 10 percent.
It is true that fighting inflation is the Central Bank’s primary job. Nevertheless, the Central Bank and the fiscal authority has to work in harmony. In the most recent midterm plan published in October 2017, the target inflation set for 2018 was 7 percent. At the time of the publication of the midterm plan, the actual inflation rate was 12 percent.
When you set your target to 7 percent, you are saying there is going to be a disinflation process of 5 percent. This can only be done if the government and Central Bank sincerely try to reach that 7 percent. Are they trying? If you look at the Central Bank’s policies throughout 2017, they raised interest rates more than 500 basis points—that is a lot of tightening. But while the Central Bank was trying to slow the economy down, the government is doing the opposite by implementing expansionary policy.
Yes, the Central Bank has made mistakes, especially in terms of their communication strategies. They have been giving confusing messages. However, promoting growth oriented policies and not helping the Central Bank in achieving the target inflation is the government’s responsibility.
Expansionary fiscal policy may be limited due to snap polls
WHO IS SELVA DEMİRALP?
Selva Demiralp was an economist at the Federal Reserve Board between 2000 and 2005, after which she joined the Economics Department at Koc University. Since 2013 she has been writing weekly articles for daily Milliyet. Over the past decade, Demiralp has had extensive interactions with several central banks including the U.S. Federal Reserve, the Central Bank of Turkey, and the European Central Bank, for which she worked as a consultant. Demiralp has received a number of grants for her research on monetary policy, including the European Commission’s International Outgoing Fellowship (IOF) and numerous grants from the Scientific and Technological Research Council of Turkey (TÜBİTAK).