Turkish Lira Capitulation As Bizarre Monetary Policy Implemented

The Turkish lira dropped to record lows against the dollar after its central bank lowered its repo rate by 100bps to 14% yesterday. This is despite an inflation rate that has surged in 2021 to above 17%. Moreover, the inflation rate has ticked up in recent months after the bizarre implementation of monetary policy, which flies in the face of traditional economic theory. The weekly chart below displays the capitulation of the TRY. The indicator is the 5-week ATR which shows the abnormal increase in volatility of the currency pair. I.e., the market has punished the Turkish lira for the strange response to higher prices.

Aggregate demand includes consumption, investment, fiscal policy, and net exports. The lowering of interest rates will cause a shift in Turkey's aggregate demand as each of these components responds. E.g., consumption may increase as the cost of credit is reduced etc. In traditional economic theory, this will result in higher inflation. Given the already elevated levels of prices in Turkey, it's no wonder that the market punished the TRY.

Turkey has responded by announcing that it will increase its minimum wage radically, by 50%, from 2022. This will cause aggregate supply to shift as the costs of production increase. I.e., cost inflation will increase and production will decline as industries adjust output to these new costs. This is an extremely dangerous economic environment to be in. All other things being equal, higher prices and lower production are the definition of stagflation, an economic policymaker's nightmare, and it will be completely self-inflicted.

Featured Image by PublicDomainPictures from Pixabay