Download The Turkish Economy, Post-2001 Crisis

The Turkish Economy, Post-2001 Crisis:
Why Timing, Faith, and Expectations Matter
Megan Chen, Ming Li Chew, Sanya Goyal, Muzoon Matar, and Zeynep Yavuz1
This paper offers a macroeconomic investigation regarding the stabilization of Turkey’s
economy following the crises it experienced in the late 20th century when Turkey began to liberalize
its economy. In the early 2000s, following decades of chronic inflation, Turkey succeeded in
lowering its inflation rate to unprecedented levels. But what caused the crisis, how did the Turkish
economy recover so well from it, and how did Turkey manage to combat mounting inflationary
pressure? The 2001 crisis was caused by structural problems, namely bad debt management and
poorly run public and finance sectors, which were detrimental to consumer confidence. After
analyzing key data and conducting surveys of literature on this subject, we conclude that the success
of Turkey’s stabilization program is due to a binding and abrupt regime change. This demonstrates
the rational expectations model, emphasizing the importance of timing and credibility of a wellimplemented program. Finally, we study the relationships between inflation and other
macroeconomic variables, and conclude that inflation growth rates remained impressively low
despite unanticipated economic shocks.
1 Megan
Chen, Ming Li Chew, Sanya Goyal, Muzoon Matar, and Zeynep Yavuz are members of the class of 2015 at the
University of Chicago. UChicago Undergraduate Business Journal
“I think the most important and priority problem in 2002 is going to be
inflation. We are rolling over our debts, there's no problem in current accounts,
we have started a slight recovery, but will we be able to curb inflation to 35
percent? Will we be able to halve inflation, which is 67 percent in 2001?"
- Turkish Economy Minister Kemal Dervis (2001)
Introduction
Research question
Turkey began implementing liberalization models in the 1990s. During this period, Turkey
experienced multiple crises that created and subsequently exacerbated inflationary pressure. This paper seeks
to address and assess the relative effectiveness of policies implemented after the 2001 financial crisis.
Our Project
This research consists of three parts: the first part aims to identify the major causes of the 2001
Turkish Crisis by analyzing key macroeconomic indicators and Turkey’s political environment between 1990
and 2001. The second part focuses on the policies implemented during the post crisis period from 2001-2006
to target inflation and fragilities present within the banking sector. The third part of this paper interprets
economic data from 2004-2010 in order to explore the stabilization of the primary variable inflation/CPI and
its correlation with other macroeconomic indicators.
Methodology
We first compiled data on the Turkish economy by referring to databases such as Federal Reserve
Economic Data (FRED), World Bank, Organization of Economic Co-operation and Development (OECD),
TURKSTAT, International Labor Organization (ILO), Central Bank of Turkey (CBRT), International
Monetary Fund (IMF) and the Turkish Undersecretariat.
We looked at several key variables that included the openness of the economy, the overnight interest
rate, total external debt, current account balance, unemployment rate, real GDP growth, M1 money supply,
consumer confidence index, net government debt, gross external debt, national debt, income share held by
income groups in 20 percentiles, state owned enterprises and total exports.
These variables were trended and graphed in MATLAB prior to being analyzed. This research relies
heavily on literature reviews of previously published research regarding the rise and fall of inflation in Turkey
from 1990-2006. The main sources were ‘Inflation Targeting in Turkey’ (Hasan, Ersel, and Fatih Ozatay),
Spring 2014
1
UChicago Undergraduate Business Journal
‘The Ends of Four Big Inflations’ (Thomas J. Sargent), Strengthening the Turkish Economy (Kemal Dervis),
"Currency and Financial Crises in Turkey 2000 –2001: Bad Fundamentals or Bad Luck?’ (F. Gulcin Ozkan),
among others.
Limitations of this Research
This research has some limitations. Firstly, a number of variables were not available on the
aforementioned databases. These variables include central bank independence measure, real interest rates, the
monetary base and statistics measuring social indicators such as censorship, freedom of speech, participation
of women in politics, and human rights abuses. In light of the above shortcomings, our research may be
relatively limited in its scope. The second limitation was the unavailability of data during certain years. This is
due to the fact that data was comprehensively and reliably recorded after the Turkish crisis of 2001 - the topic
of interest in this paper. A third limitation was the scarcity of literature to corroborate or contradict our
analysis of the data, and our own restricted knowledge on topics such as the foreign exchange market and a
pegged exchange rate regime, which played a significant role in the Turkish crisis of 2001.
Part I: Rise of Crisis, 1990-2001
General Overview of Turkey, Pre-2001 Crisis
Turkey experienced several economic crises during the 1990s. Many critics argue that the instability
of the Turkish economy during the 1990s was due to a lack of implementing necessary legal and institutional
reforms following the liberalization of the Turkish economy in the early 1980’s (see Ozatay and Sak, 2002,
Ozkan 2005, Yeldan, 2002). Turkey was able to handle small crises during the last decade of the 20th century
with relatively minor damages to the economy. Since no measures were taken to safeguard the economy
against potential future crises in the future however, the vulnerability and instability of Turkish economy
continued to grow.
Spring 2014
2
UChicago Undergraduate Business Journal
Figure 1.1: Inflation
Source: Organisation for Economic Co-operation and Development
Throughout the 1990’s, Turkey suffered chronic inflation ranging between 70-90%, as shown in
Figure 1.1 (Ozkan, 2005). To combat such inflationary pressure, Turkey adopted a stabilization program in
1999 with the backing of the IMF. The program adopted was a pegged exchange regime, and the two
essential requirements for the success of the program were tight monetary policy and the liberalization of the
economy.
As shown in Figure 1.1, the stabilization program had a positive impact on Turkey’s economy during
its initial stages. The inflation rate declined, and the interest rates on Treasury Bills fell from 90% to 40%
(Ozkan, 2005). In November of 2000, however, about a year after the stabilization program was adopted, the
Turkish economy experienced a liquidity crisis, which was further worsened by the severe depreciation of the
Turkish Lira in February 2001.
The liquidity squeeze2 in November 2000 was a result of severely increasing interest rates. Despite
the decreasing inflation due to the newly adopted stabilization program, interest rates started to fluctuate well
before the crisis took place. While overnight interest rates fluctuated between 18.9% and 45.9% in April 2000
and between 13.6% and 38.8% in July 2000, interest rates fluctuated between 23.7% and 79.6% in September
and peaked at 315.9% in November and 873.1% in December (Koch and Chaudhary, 2001). A record of the
The liquidity crisis Turkey experienced was a result of the reduction in the general availability of loans and credit
available for consumers and businesses in the bank reserves.
2
Spring 2014
3
UChicago Undergraduate Business Journal
overnight increase in the interest rates is also shown in Figure 1.2. The rise in the interest rates made it more
difficult for banks to sell holdings of government bonds and maintain liquidity. Due to the liquidity crisis, the
fall in inflation lessened, and, as a result, Turkey was not able to reach its target level of inflation, causing the
544
F. GULCIN OZKAN
Turkish lira to become further overvalued.
FIGURE 1
Overnight Interest Rates, 1 November–26 December 2000
Figure 1.2 Overnight Interest Rates (Ozkan 2005)
Source: The Central Bank of the Republic of Turkey.
in the markets. However, the Turkish lira continued to be overvalued as a result
of the slow
fall in inflation.
Against
thisas background,
a public
disagreement
On February
21st 2001, also
known
“Black Wednesday”,
Turkey
experienced the most serious
between the Prime Minister and the President was followed by a massive attack
financial
and economic
in its post-war
history.
A few days decided
earlier, specifically
on February 19th, a heated
on the Turkish
lira oncrisis
21 February,
2001.
The authorities
to float the
currency the
following
daythe
with
a 28Minister
per centEcevit
loss ofand
value
against
the dollar.
argument
emerged
between
Prime
President
Sezer,
during In
which Sezer threw the
the subsequent two months, the Turkish lira lost almost half of its value. The
constitutional
book
the Prime
Minister
warned
ominously
that nine
“Thisper
is a serious crisis.” Many
resulting output
lossatwas
substantial
andand
the Ecevit
economy
contracted
by over
cent in 2001,
whichstatement
was the nation’s
most severe
recession
World
War II.4 (Ozatay and Sak, 2002).
understood
Ecevit’s
to be admission
of defeat
by thesince
Turkish
government
The next section aims to identify the sources of these currency and financial
And two days after this political clash the Turkish Lira collapsed. By the next month, it had lost almost half of
crises and provide alternative explanations. The first, fundamental-based explanaits
value.
The the
economy
proceeded
to contract by
9% in 2001
(Ozkan,
tion,
utilises
first- and
second-generation
currency
crises
models2005).
for the identificationThe
of aaim
setofofthis
potential
second,
financial
fragility-based
part of fundamentals.
this paper is toThe
identify
the causes
behind
the 2001 Turkish crisis. It will be
explanation, relies on the third-generation models in specifying fragility measures
comprised
of two as
parts:
the firstfor
willa display
between
1990-2000,
that were useful
indicators
numbereconomic
of other data
emerging
market
crises.which will show Turkey’s
We present
data over
different spans.
First, we
look at the
increasing
trade-deficit
andthree
disproportional
government
borrowing;
the evolution
second willofanalyze the crisis and
the likely indicators during the period immediately before the crisis, over the
explain
how the fragility
of thewe
banking
sector
became in
thethe
major
cause behind
the 2001 collapse of the
period 1999–2000.
Second,
inspect
the change
potential
determinants
throughout
the 1990s for medium-term tendencies. Third, for some of the variables
Turkish
Economy.
we go as far back as the early 1970s to put the crisis period into some historical
4
Financial Times (2 April, 2002).
© Blackwell Publishing Ltd 2005
Spring 2014
4
integration of domestic economy into world economy. As a result, trade and FDI
increased significantly as depicted in Table 1. However, there is need to carefully
examine the measures undertaken to encourage FDI and to liberalise the financial
Undergraduate
sector of the country and to properly understand the UChicago
consequences
of its crises.Business Journal
To encourage FDI, the government issued “The Foreign Capital Framework
Decree” in 1980. It simplified the administrative procedures of FDI and capital flows
Liberalization of the Turkish Economy: Historical Background
and established a separate institution called “The Foreign Investment Directorate”.
TurkeyAlthough
has been transforming
intoissued
a market
since the
1970s.and
It is1984
important
to note,
the government
twoeconomy
other decrees
in 1983
to relax
the
constraints
on
FDI,
it
enacted
more
fundamental
FDI-related
measures
in
1985
and
however, that a certain degree of government intervention still existed within the economy. This intervention
1986, which led to the formation of free trade zones, removal of restrictions on foreign
came in the form
of the participation
government’s and
influence
over the Central
decisions
and its
ownership of
equity
discontinuation
of Bank’s
minimum
export
requirements.
Consequently,
of foreign
equity
ventures increased
2900 guidelines
and foreignthat
capital
commercial banks.
Starting in number
the 1980s,
the Turkish
government
began totoadopt
would
inflows to US$7,572 million during 1980 to 1995 [Tatoglu and Glaister (1996)].
minimize government However,
intervention
and liberalize
theiradministrative
market model, obstacles
currency and
trade (Koch
despite
the decrees,
are foreign
still pervasive
in and
the As
country.
cost
in various
ways.
Forin example,
World Business
Survey
Chaudhary, 2001).
a result,They
foreign
direct
investment
(FDI)
Turkey increased
and its external
balance of
reported that investors in Turkey spend 20 percent of their time in meeting official
trade became a significant denominator in Turkish economy. Table 1.1 depicts the increases in exports,
formalities compared to 8 percent in East and Central Europe. Similarly, Price
imports and FDI
in the late Coopers
20th century
in Turkey.
Waterhouse
argues
a number of regulations are not easily understandable
and widely applicable. Such a state of affairs creates uncertainty and thus costs the
2
$1,822 million
Table 1.1 (Kochcountry
and Chaudhary,
2001)annually.
Table 1
Imports, Exports, and Net FDI into Turkey, 1970–1990
(Million Dollars)
1970 1973 1976 1978 1980 1981 1983 1985 1988 1990
Exports
588
1,317 1,960 2,288 2,910 4,703 5,905 8,255 11,929 13,026
Imports
948
2,086 4,872 4,369 7,513 8,567 8,895 11,230 13,706 22,581
FDI
58*
–
–
–
18
141
87
158
387
788
Source: State Planning Organisation, Undersecretariate of Treasury.
* Total capital flow, both inflow and outflow.
1
Turgut Ozal worked as a Deputy Counselor in the Prime Minister’s office from December 1979
till
the
military
in September of
1980,
during trade,
which he
“January
24 Economic
In order to measure coup
the significance
external
weprepared
analyzed
the changes
in thePackage”.
openness of
After the military intervention, he first became a State Minister, then Deputy Prime Minister until July
1982.between
On winning
election with
theopenness
help of self-found
Motherland can
Partybe
in measured
May 1983, he
Turkish Economy
1970-2000.
The
of an economy
bybecame
takingPrime
the total of
Minister. He was Premier till November 1989 when he became the President of the country. He died in
exports and imports
a proportion
of while
GDP.
displays how the openness of the Turkish economy
1993 ofasa sudden
heart attack
he Figure
was still 1.3
the President.
2
http://www.hazine.gov.tr/ (official site of the Treasury).
increased sharply after the government implemented efforts to liberalize the economy in the early 1980s. In
line with this finding, the next section will analyze Turkey’s trade balance during the increase in the openness
of Turkey’s economy.
Spring 2014
5
UChicago Undergraduate Business Journal
Figure 1.3 Openness
Source: The University of Pennsylvania
Worsening of the Trade Balance and Current Account Balance
The trade balance of a country is defined as its exports minus its imports, and it measures the deficit
between revenue from exports and payment for exports. The current account balance is another measure of a
trade deficit, and it is the sum of trade balance, factor income and cash transfers. Figure 1.4 plots the changes
in the current account balance in the last decade of the 20th century. As shown in Figure 1.4, we observe a
decline in Turkey’s current account balance. The OECD’s 2001 Economic Survey of Turkey identifies the
worsening of the current account deficit as one of the main sources behind the collapse of the economy
(Ozkan, 2005). Table 1.2 provides the trade balance and current account balance records during the pre-crisis
period. A sharp decline in both values becomes evident according to these variables. Specifically, the trade
balance experiences a severe decrease in the year 2000. The reason behind the worsening trade-balance is the
weak competitiveness of the Turkish Lira, and this will be explored in more detail in the next section.
Spring 2014
6
UChicago Undergraduate Business Journal
CURRENCY AND FINANCIAL CRISES IN TURKEY 2000–2001 549
Table 1.2 (Ozkan, 2005)
TABLE 2
Trade and Current Account Balances, 1996–2000 (in million US dollars)
Year/Quarter
1996
1997
1998
1999
2000
2000
2000
2000
2000
Q1
Q2
Q3
Q4
Trade Balance
−10,582
−15,358
−14,220
−10,443
−3,794
−5,938
−6,253
−6,311
−22,341
Current Account Balance
−2,437
−2,638
1,984
−1,360
−2,282
−3,265
−1,194
−3,024
−9,765
Source: Central Bank of the Republic of Turkey at www.cbrt.gov.tr
1.4 Current
Account
Balance
To Figure
the extent
that these
balances
can be used as warning signals for the
fragility of the peg, there was some cause for concern especially from the second
quarter of 2000 and increasingly so in the lead up to November 2000.
Competitiveness: One of the underlying sources of movements in both the trade
and the current account balances is the competitiveness of the external sector. In
high inflation countries where an exchange rate-based programme is put into
place, the evolution of domestic inflation is a key determinant of competitiveness. If domestic inflation is above the foreign one, competitiveness of the home
country will be eroded given that the exchange rate cannot respond to do the
necessary adjustment. This, in turn, damages the credibility of the peg. In the
case of Turkey, a crawling peg against a dollar-euro basket was at the centre of
the stabilisation programme. There was a pre-specified timetable of devaluation
rates until the end of 2002.
Figure 5 plots the inflation performance over the past three decades. Clearly,
the recent stabilisation programme was successful in reducing inflation which
had been on a sharp upward trend since the 1980s. However, it is important to
note that, notwithstanding this reduction, inflation rates for 2000 and 2001 stood
at over 40 per cent, which were still above the target devaluation rates. This, in
turn, resulted in a non-negligible loss of competitiveness of the Turkish economy
over this period.9,10
This view is also reinforced by the results of a survey conducted by the International Institute for
Source: International Monetary Fund
Management Development (IIMD). The criteria assessed by IIMD have wider coverage and incorporate government efficiency, business efficiency and infrastructure in addition to economic
performance. The resulting World Competitiveness Index ranks Turkey as the 46th among the
Table 1.3 displays Turkey’s imports, exports and FDI between 1990-2000. A reading of the table
50 surveyed in 2000 (The Economist, 5 May, 2001, p. 124).
10
Akyuz
and Boratav
(2001) observe
that current
exchangedeficit
rate-based
stabilisation
shows
a continuous
rise in the
(Uygur,
2001). programmes
In 2000, theadopted
trade-deficit to GNP ratio exceeded
by other high inflation countries were considerably more successful in reducing inflation. For
9
its safe limit of 3.5%, correlating the rise in the risk premium of interest rates on foreign debt (Koch and
© Blackwell Publishing Ltd 2005
Chaudhary, 2001). Table 1.4 shows that the ratio of monthly current deficit to foreign currency reserves
jumped from 6% to 50% during 2000, signaling the occurrence of the second crisis in February 2001.
Spring 2014
7
UChicago Undergraduate Business Journal
Table 1.3 (Koch and Chaudhary, 2001)
Table 2
Foreign Trade and FDI, 1991 to 2000
(Million Dollars)
Year
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
Export
13,593
14,715
15,345
18,106
21,637
23,224
26,261
26,974
26,587
27,485
Import
21,047
22,871
29,428
23,270
35,709
43,627
48,559
45,921
40,687
54,150
FDI
910
912
797
937
935
937
873
982
823
1307*
FDI Outflow
127
133
175
78
163
325
319
409
685
718*
Source: Central Bank, State Planning Organization, and Undersecretariate of Treasury.
*January-October
February
2001 Crisis in Turkey
Table 1.4 (Koch and Chaudhary,
2001)
473
Table 3
Selected Financial Indicators for 1999 and 2000
Monthly Current
Treasury
Deficit/Foreign Compound Interest,
Date, Currency Reserves
Average
Months
(%)
(%)
1999 10
109.3
11
96.4
12
5.9
– (*)
2000 1
10.2
38.3
2
15.2
42.1
3
21.5
39.9
4
22.9
34.5
5
26.7
39.4
6
27.7
41.9
7
28.6
34.5
8
33.5
33.2
9
33.6
33.6
10
39.2
38.0
11
46.7
41.0
12
49.7
Consumer Price
Increase, 12
Month
(%)
64.7
64.6
68.8
68.9
69.7
67.9
63.8
62.7
58.6
56.2
53.2
49.0
44.4
43.8
39.0
Wholesale Price
Increases, 12
Month
(%)
55.2
56.3
62.9
66.4
67.5
66.1
61.5
59.2
56.8
52.3
48.9
43.9
41.4
39.1
32.7
Source: Uygur (2001) “Krizden Krize Turkiye: 2000 Kasim ve 2001 Subat Krizleri”.
* No bid in December 1999.
Indeed, this crisis had diverse effects on the nation. For example, 4,146 firms
there were trade-deficit,
large-scale it was also facing an
were So,
closed
in thenot
first
three
the crisis7 and
overall,
only
wasmonths
Turkeyofexperiencing
a worsening
demonstrations against government in many cities disturbing production, commerce,
increasing
risk premiumand
onlaw
interest
ratesinfor
foreign
According
to the
Koch and Chaudhary (2001), the
trade, communication,
and order
theits
country.
Todebt.
control
the situation,
Premier of Turkey invited Kemal Dervish, Vice-Director of the World Bank to
rise in the risk premium on interest
rates was a result of the political instability Turkey experienced during the
control and manage the economy.8 He was appointed a State Minister to look after
the whole
economy.
quicklyofembarked
the preparation
of two
a newpresidential
programme elections and four local
1990s.
During
the lastHe
decade
the 20th upon
century,
Turkey had
of actions regarding legal and structural reforms, which did not receive proper focus
elections
caused
government
expenditure
to rise.
Furthermore,
Turkey
had ten different governments in
in the that
previous
programme.
However,
one question
frequently
asked is:
Had the
outcome
been
different,
if
a
different
disinflation
policy
had
been
followed
in adopted economic
power between 1989 and 2000. Each shift in government interrupted previously
Turkey? The answer is, possibly not, because the crisis had resulted not from one but
development
stabilization
programs
that inhibited steady improvements in the Turkish economy. As a
from severaland
adverse
factors discussed
ahead.
7
result of political
instability
and uncontrolled public expenditure, both domestic and foreign debt increased
The Radikal,
April 29, 2001.
8
It is alleged that the Premier had invited Kemal Dervish on behest of IMF, World Bank and the
aid to Turkey. It is, however, believed that it was not the
administration of foreign aid alone. The strategic position of Turkey in the world geography was a more
important consideration, which prompted the appointment of a person of their confidence. How important
Turkey is strategically may be ascertained from what Stanley Fischer of IMF said: “Turkey is not an
ordinary country, it is a member of NATO as well as has a big economy”(The Economist, May 19, 2001,
pp. 54.) Although they admitted the strategic importance of Turkey, they had reservations about its
officials’ honesty in using foreign aid.
(Koch
Chaudhary,
2001).foreign
USA and
to administer
the committed
Spring 2014
8
UChicago Undergraduate Business Journal
Weak Competitiveness of Lira
As mentioned in the previous section, Turkey experienced a trade-deficit due to the weak
competitiveness of the Lira, as a weak competitiveness of a currency translates into weak competitiveness of
exports. Since Turkey adopted the pegged exchange rate program, domestic inflation measures became a
major determinant of the competitiveness of the Turkish economy. If domestic inflation increased at a faster
rate than the foreign inflation rate, this would erode the competitiveness of the Turkish economy. This is
because the fixed exchange rate cannot respond to necessary adjustments. As a result, the credibility of the
peg declines (Ozkan, 2005).
If we look back to Figure 1.1, we see that, although the stabilization program has been successful in
quickly decreasing the inflation rate from 90% to 40%, inflation still remained above the targeted inflation
rate of the program. This became the major reason for the weakening of the competitiveness of the Lira.
Increase in the Debt Balances and Decrease in the Ability to Pay Debt
Figure 1.5 plots the total external debt balances of Turkey between 1990-1999, and it reveals an
increase in Turkey’s external borrowing. Specifically, the total gross debt of Turkey rose from $4.5 billion in
1990 to $9.5 billion in 1999. What is disconcerting is the fact that Turkey’s short term borrowing increased
drastically, not only foreshadowing problems within the banking sector but also on how Turkey’s ability to
pay back its debt was fragile and unsustainable.
Spring 2014
9
UChicago Undergraduate Business Journal
Figure 1.5 Total External Debt (US dollars in millions)
Source: Central Bank of Turkey
This can be shown by comparing Turkey’s short and long term borrowings, as presented by Table
1.5. Although both values seem to display an overall increase in 1997, there is evidence of a sharp increase in
short term borrowings. Figure 1.6 plots the distribution of short-term debt between the recipients of the debt.
The graph shows that most short-term debt was taken on by commercial banks. This evidence signals the
fragility of the banking system in the 1990s, which will be discussed in the second part of this research.
Spring 2014
10
regime itself. Therefore, Total
in what
follows
we present
a profile
of the external
External
Debt, 1971–2001
(US dollars,
in millions)
borrowing structure in Turkey during the 1990s.
Table 3 presents data on the annual percentage change in the total outstandUChicago Undergraduate Business Journal
ing external
debt
by
maturity
since
1997,
which
highlights
the
sharp
rise in
short-term borrowing over this period. Figure 9 provides information on the
Table 1.5 (Ozkan, 2005)
FIGURE 8
Year
1997
1998
1999
2000
2001 Q1
2001 Q2
TABLE 3
Annual Percentage Change in Total Outstanding Debt
Change in Short-term Debt
4.05
17.56
10.63
23.18
−7.87
2.01
Change in Long-term Debt
7.28
13.27
5.65
11.21
−1.13
0.25
Source: The Undersecretariat of Treasury at www.treasury.gov.tr
Source: World Bank (1971–1995); The Undersecretariat of Treasury (1996–2001).
© Blackwell Publishing Ltd 2005
Figure 1.6 Distribution of Short-term Borrowing (Ozkan, 2005)
FIGURE 9
The Composition of Short-term External Debt, 1990–2001 (US dollars, in millions)
Source: Datastream.
© Blackwell Publishing Ltd 2005
Turkey’s ability to service its debts can be measured by taking the ratio between debt balance and
GDP, and the ratio between debt balance and exports. The first ratio measures the current capacity to pay
back debt in absolute amounts and the second ratio measures the capacity of the Turkish economy to
generate revenue to pay back its debts (Ozkan, 2005). Table 1.6 provides us with the aforementioned ratios
and shows alarming declines in both ratios, implying that Turkey’s capacity to service its debt was steadily
weakening. Furthermore, the table shows that the ratio between interest rates on borrowing and exports was
also increasing. This measure once again shows the heavy burden placed on foreign currency earnings,
especially in 1999 and 2000 (Ozkan, 2005).
Spring 2014
11
UChicago Undergraduate Business Journal
CURRENCY AND FINANCIAL CRISES IN TURKEY 2000–2001 555
Table 1.6 (Ozkan, 2005)
Years
1996
1997
1998
1999
2000
TABLE 4
Some Fragility Measures of the External Sector
Debt Service/GDP
6.22
6.46
7.99
9.89
10.90
Debt Service/Exports
49.16
47.29
61.22
68.89
78.98
Source: The Undersecretariat of Treasury at www.treasury.gov.tr
Interest on External Debt/Exports
18.08
17.47
17.88
20.50
22.68
TABLE 5
Debt Service as a Ratio of Exports, Experience
many other of
emerging
economies,
has underdeveloped
East Asian
Countries, 1996
Fragility of the Banking Sector
Turkey, as
bond and equity markets. Thus,
capital transactions, inflows,
by the banking sector. Despite the liberalization of
Countryand outflows are mediated
Debt Service/Exports
Turkey’s economy, the Korea
banking system remained8.80
integral to the Turkish economy in the 1990s. Many argue
Indonesia
that the weakness of the
banking sector was the36.80
main contributor to Turkey’s macroeconomic instability
Malaysia
8.20
Philippines
during 1990-2000 and the
stock market crash in13.70
2001 (Ozatay and Sak, 2002, Ozkan 2005, Yeldan, 2002).
Thailand
Source: Corsetti et al. (1998a).
11.50
Lack of proper regulation and institutional frameworks in the banking sector was an evident problem within
the Turkish economy. (Ozkan, 2005) The lack of independence of the banking sector from the government
became the major problem of the banking sector’s framework.
For comparative purposes, Table 5 provides the ratio of debt service to exports of
a number of East Asian countries prior to the Asian crisis. A glance at these two
tables suggests
that the worsening
Corruption
and Political
Favoritismof the external balance and the debt-servicing
ability in the pre-crisis period was much worse in Turkey than any of the troubled
weakness
ofto
thetheir
banking
sector was
largely due to the corruption endemic within state run banks.
Asian The
countries
prior
respective
crises.
above
discussion
of the
the state
vulnerability
of the external
focusedcredits
on to favored groups.
The The
Turkish
government
used
banks to distribute
policiesaccount
of preferential
an evaluation of a number of separate indicators. A more appropriate way of
Asanalysing
a result, banks
accumulated
big losses
that
paid the
by the
in themeasure
form of government securities,
external
sustainability
would
bewere
through
useTreasury
of a unified
combining
indicators
of external
debt
burden
and the health
of was
tradethebalances.
thereby
damaging
the liquidity
of these
banks.
An additional
problem
morally conflicting role of the
One such measure has been proposed by Chalk and Hemming (2000) which is
Council of Ministers. The Council of Ministers had the right to decide on the entry and exit of banks. As a
based on the notion that external sustainability is only possible when the path of
result,
bank balance
licenses leads
were granted
to politicallyforeign
favoredliabilities
individuals.
And,
since the political authority was
the trade
to non-increasing
over
time.
Now
consider
the
following
relationship
between
net
foreign
liabilities
and 2005). It is also
acting under the pressure of banks, it was not able to take any regulatory actions (Ozkan,
trade balances:
important to recall the unstable political scene during the 1990s when the Turkish government was
+ qt)(1 +parties.
nt)ft+1 The
= R*tpolitical
ft − tbt authorities had high incentives
(1)
overwhelmingly composed of(1coalition
to use their power
for
political
but no intention
apply corrective
regulatory
it spelled
where
q isfavoritism
the real appreciation
of the to
currency,
n is the growth
rateaction,
of realas
output,
f short-term
is the net foreign
liabilities
defined ashighlight
external the
debtnecessity
minus foreign
assets including
disadvantages
for them.
These– problems
of an autonomous
regulatory body for the
© Blackwell Publishing Ltd 2005
banking sector.
Spring 2014
12
UChicago Undergraduate Business Journal
Maturity Mismatches Between the Assets and Liabilities of the Banking Sector
Banks are defined as financial intermediaries that have mostly short-term deposits as liabilities and
loans to businesses and consumers as assets (Koch and Chaudhary, 2001). When a bank’s liabilities exceed its
assets, the bank becomes insolvent, and this was precisely the case during the 1990s in Turkey.
One key factor contributing to the insolvency of the banks was their practice of giving out shortterm credit that was funded by foreign loans. The increase in short-term borrowings by banks has already
been addressed earlier in this paper. Banks increased their consumer lending because the profitability of
holding government securities declined due to the lower interest rates offered on government securities in
2000 (Ozkan, 2005). This increase is visible in Figure 1.7 that graphs the bank lending to private sector
between 1990-2000.
566 1.7 Bank Lending to Private
F. Sector
GULCIN
OZKAN
Figure
(Ozkan
2005)
FIGURE 15
Bank Lending to Private Sector, January 1986–December 2001 (TL, in trillions)
Source: The Central Bank of the Republic of Turkey.
Such
increases
in foreign
borrowing
which
was their
mostly
short-term
During
the 2001
crisis, foreign
creditors
called
loans
back due –toasthedocuinstability being
mented above – also introduced significant maturity mismatches between the
experienced
theliabilities
Turkish economy.
As a result,
domestic
banks increased
their purchases of foreign
assets andbythe
of the banking
sector.
In addition,
banks increasingly
turned to
consumer
lending
as the
profitability
securities
currency,
thereby
causing
domestic
currency
reservesofofholding
Turkishgovernment
banks to decrease
and increasing the
greatly decreased as a result of lower interest rates offered by them in 2000. This
pressure
on visible
exchange
rates.
Although
the government
closed
public
sector
is clearly
from
Figure
15, which
plots bank should
lendinghave
to the
private
sector
in banks that were in the
Turkey
duringstayed
the 1990s.
This
boom worsened
the the
maturity
red,
these banks
open due
to lending
political reasons.
Once again,
lack ofmismatch
an independent regulatory
that was already growing. It is argued that banks had not developed the expertise
authority of the banking sector caused the budget deficit by increasing the debt stock. Furthermore, increased
to deal with the resulting interest rate and exchange rate risks (see, for example,
23
government
borrowing
privatemismatches
banks also distorted
performance
of private
banks, since private
OECD, 2001).
Suchfrom
maturity
have not the
prevented
the already
risky
banks
from
offering
even
higher
deposit
rates
to
remain
in
business.
The
overall
bank reserves failed to finance the budget deficit caused by state-run banks (Koch and Chaudhary, 2001).
result was ever-decreasing profitability over 1999–2000. This can be seen from
Table 9 that presents data on loans quality and the profitability of the Turkish
banking system. It is evident that both the shares of non-performing loans in total
loans and the profitability deteriorated during 2000.
Spring 2014
The above discussion of the increase in the banks’ foreign borrowing suggests
that there were substantial capital inflows into Turkey in the wake of the adoption
23
13
UChicago Undergraduate Business Journal
After the liberalization of the Turkish economy in the early 1980s, Turkey has experienced several
economic crises and downturns. February 2001 was the most severe of these crises. A good understanding of
the causes behind the 2001 crisis lays out the major fractures that were present in the Turkish economy. This
crisis not only exposed the pervasive corruption present within the Turkish economy to the people of Turkey
but also to the world. Thus, we have shown that the 2001 crisis was an outcome of the combined effects of
unsound fiscal policy, corruption, government intervention in the economy, excessive debt, loss of
competitiveness of the Turkish Lira and record levels of interest payments on borrowing. Structural reform
of the financial sector was necessary not only to solve the 2001 crisis but also to put the Turkish economy on
a successful path to prevent similar crises from occurring in the future.
Part II: Inflation Stabilization Programs and the Rational Expectations Model, 2001-2006
Strengthening the Turkish Economy
The vast number of crises experienced in Turkey pre-2001 are strongly tied to poor regulation and
structuring of the public and financial sector, which were also necessarily entangled in a volatile political
undercurrent. Attempts to reconcile these crises consistently took on a neoliberal approach, which often lead
to more instability since these efforts were never properly regulated. This only served to hurt the credibility of
the Turkish government’s economic programs (Ozatay, 2002). These premature and poorly executed
implementations reveal the importance of timing in the propagation mechanism of rational expectations in
the context of rising inflation rates.
The 2001 financial crisis was no different in that it was largely a result of political uncertainty and
volatility. Six days after Black Wednesday, the government decided to float the Turkish Lira, which again shot
up the overnight inflation rate to 4024.7% (Dervis, 2003). This uncertainty created a worsening situation for
the banking system, leaving the Turkish economy in shambles. Due to the negative perception of the Turkish
economy in the global financial markets, a buffer period was necessary before a formal inflation-targeting
program could be implemented. The reforms following the 2001 financial crisis from 2002-2005 acted as this
buffer period, formally known as Strengthening the Turkish Economy (Central Bank of Turkey). The aims of this
program were to provide a strong backbone for the formal inflation-targeting program that would be
introduced in 2005. The implicit approach, introduced in 2001, emphasized balancing the budget, increasing
competitiveness and restoring faith in the market and the credibility of the Turkish economy. To do this, the
program aimed to increase transparency and accountability in resource allocation within the public sector,
strengthening and formalizing good governances to fight corruption, restructuring the banking sector and
balancing public finances by instilling macroeconomic discipline (Ozatay, 2008). These lofty goals required
frontloading structural reforms, that is, effectively implementing an abrupt regime overthrow in a timely
manner to boost confidence.
Spring 2014
14
UChicago Undergraduate Business Journal
Figure 2.1 : Annual Inflation Rate Changes, 1980-2010
As seen in the figure above, inflation peaked during the 1994 crisis and began to subside consistently
in conjunction with the liberalization of the Turkish economy, experiencing a sharp decline after the
implementation of the 2001 crisis programs, before finally stabilizing in 2005. This section attempts to explain
the necessity of an implicit inflation targeting approach before a formal targeting approach could be
introduced in 2005.
Restructuring the Public and Finance Sectors
The legal amendments necessitated a restructuring of the public sector, including state-owned
enterprises, as well as reforming the banking sector. This included the privatization of previously state owned
industries in Turkey’s economy that included civil aviation, Turk Telecom, sugar, tobacco, and natural gas
(Central Bank of Turkey). Moving forward, these industries were no longer controlled by the state, increasing
competitiveness and efficiency by relying on market prices in order to reduce waste. Lastly, there was a
complete restructuring of the banking sector, which affected the state owned Saving Deposit Insurance Fund
(SDIF) and private banks. This included consolidating and shutting down many low performing banks as well
as letting go of employees who performed repetitive jobs.
Spring 2014
15
UChicago Undergraduate Business Journal
The Banking Sector Restructuring Program was introduced in May 2001 and focused on heavily
reforming state owned banks and increasing competition. The state-owned banks needed restructuring due to
treasury debt they had accumulated, which was securitized by using government issued bonds. The state
owned banks were merged into two main banks, retrenching a lot of employees with similar responsibilities
and laying off inefficient labor in the hopes of allocating resources more efficiently (See Figure 2.2). Also, the
management of these banks was transferred to a newly appointed autonomous Board of Directors to oversee
prudence with sub-prime loans and to ensure transparency and accountability. SDIF banks underwent similar
changes that included merging banks and cutting labor, both of which that had aided the private banking
sector. This was paired with prudent capital requirements, including a strengthening of the banks’ capital base
in order to ensure their ability to pay back liabilities (Ozatay, 2008).
Figure 2.2: The decline of state-owned enterprise 1984-2010
As seen in this figure, both reforms to the private and public sector significantly reduced state-owned
enterprises and public sector employees, a trend that continued into the new millennium. This was a measure
to ensure that public and private sectors were running efficiently while aiding competition within industries
by reducing state-owned enterprises. By merging banks and cutting employees, the state increased reserves
while sacrificing employment rates.
Spring 2014
16
UChicago Undergraduate Business Journal
Balancing the Budget
Figure 2.3: Gross Government debt
Unsustainable public debt obligations skyrocketed during the 2001 financial crisis. In turn the hike in public
debt led to a higher perceived risk of default which increased the real interest rate, placed upward pressure on
the cost of borrowing and caused debt sustainability to go down (Ozatay, 2008). Thus legal reparations were
necessary in order to balance the budget. During this time, 15 budgetary funds were closed and the central
bank became completely independent in order to divorce itself from politics. To safeguard the economy from
corruption, regulatory economic and social councils oversaw the implementation of reforms in order to
increase transparency and accountability while managing public debt. During this time, exports significantly
increased, in addition to the public sector reforms mentioned earlier, which reduced the number of
government employees. This helped balance the budget by late 2006, as shown by the steady drop in gross
public debt, as shown in Figure 2.3.
Spring 2014
17
UChicago Undergraduate Business Journal
Figure 2.4: Total Exports, 1986-2006
This figure shows the steep rise in exports in conjunction with the new liberalization model of Turkey,
increasing openness to foreign trade and helping balance the budget deficit.
Formal Inflation Targeting in 2005
The buffer period directly following the 2001 financial crisis was necessary in order to restore
confidence in the market and to boost expectations by creating more transparency and accountability in
Turkish economic programs. Effectively, the implicit inflation targeting approach fully liberalized the Turkish
economy by privatizing and optimizing the public sector. In 2005, following growth in consumer confidence,
a formal inflation-targeting program was introduced. The new program acted as a more aggressive
continuation of earlier reforms
The central bank increased reserves by reforming the tax structure, i.e. collecting more taxes,
reforming agriculture programs, and social security. In 2006, the Turkish Lira was redenominated by
dropping the zeros in hopes of re-establishing credibility and improving consumer’s inflationary expectations
by making the currency more comprehensible to consumers. This practice effectively improves consumer
perceptions about future prices, which aids inflationary expectations, thereby helping stabilize price increases
(Mosley, 2005). This was done concurrently with setting new inflation targets and setting up more regulatory
Spring 2014
18
UChicago Undergraduate Business Journal
boards, including the Monetary Policy Committee, in order to increase the quality of both monetary and fiscal
discipline, transparency, and accountability.
The Role of Expectations in the Economy
The economy was stabilized after the introduction of the formal inflation-targeting program
introduced in 2005. This was only possible due to the frontloading structural reforms implemented in the
public and financial sector while simultaneously balancing the budget as Turkey fully transitioned into a
neoliberal model of monetary and fiscal policy in 2001. The introduction of neoliberal policies however
coincided with the first major crisis of 1994, and disinflation programs were rarely sustainable, leading to
more poorly implemented neoliberal policies, which perpetuated instability in the economy. Hence, after the
2001 crisis, the Turkish government first implemented an implicit inflation-targeting program that included a
strict and thorough regime change that segwayed into a formal inflation reduction program in 2005, which
truly stabilized the Turkey’s inflation rate. This implicit targeting was necessary due to the impaired credibility
of the government’s economic programs from previous crises paired with low accountability and
transparency. These structural reforms effectively depoliticized Turkey’s economy, which was often the main
source of volatility in consumer confidence due to corruption, poor regulation, and inefficient allocation of
resources in important sectors of the economy. The reforms accomplished this de-politicization by privatizing
industry, setting stricter borrowing laws, and reforming the banking sector. The reforms also coincided with a
restoration of sustainable confidence in the market, proving the effectiveness of rational expectations model.
This explains how the reform program after the 2001 crisis was a necessary buffer in order to restore
credibility and faith in the market before a strict inflation-targeting program, which finally served to stabilize
inflation. In contrast to earlier reforms, a successful stabilization program in developing countries, given
Turkey as a case study, necessarily combines a binding and abrupt regime reformation with the expectation that
is widely believed to be successful. This emphasizes both the importance of timing and credibility of a wellimplemented program.
The Rational Expectations model explains the inherent momentum of current-day inflation. That is,
consumers expect high inflation due to the government’s current and prospective monetary and fiscal policy.
It states that inflation responds slowly to isolated policy, and rather the momentum is a result of long-term
government policy of large deficits financed by printing money at a high rate. Therefore, inflation can be
stopped much more quickly than the momentum view allows as long as there exists a change in policy
regime. This needs to be an abrupt change in government policy or strategy for setting deficits now and in the
future that is sufficiently binding so that it may be widely believed (Sargent, 1981). This explains how the
stabilization in Turkey occurred so rapidly. Since the frontloading of structural reforms in Turkey included
the de-politicization of the economy, consumer confidence was positively affected by increasing the
perception of accountability and transparency. The actual effectiveness of the accountability protocol is not as
Spring 2014
19
UChicago Undergraduate Business Journal
important as the consumer perception surrounding these policies. Expectations matter so much because they
are tied to future growth; they are, however, derived from past and current perceptions.
Part III: Inflation Relation to Other Macroeconomic Variables, 2004-2010
The following section will be concerned with analyzing the relationship between inflation and other
macro-economic variables. This section provided many interesting and fresh insights into the Turkish
economy - specifically underscoring the Turkish government’s commitment to controlling inflation in the
face of both positive and adverse shocks.
Firstly, the fact that inflation remained stabilized since 2005 signaled progress in the Turkish
economy. This is important because stable price levels do not only boost consumer and investor confidence,
accelerating the success of any governmental programs to push Turkey forward. They are also an indicator
that the Turkish government had become better equipped at predicting people’s rational expectations. As
such, consumer and investor confidence along with the concept of rational expectations play a significant role
in explaining the discrepancies between our observations of the Turkish economy and those of theoretical
predictions.
Figure 3.1: Inflation/CPI and Unemployment Rate
Intuitively, inflation/CPI growth and the unemployment rate have no relation to one other.
Although higher inflation levels may correspond to lower unemployment levels in the short-run because
monetary growth does indeed have a positive effect on the economy, this does not continue in the long-run,
because by virtue of being in the long-run, variables adjust in response to the economy-wide rise in prices and
unemployment returns back to pre-inflationary levels. This theory is more commonly known as the Phillips
Curve3.
In the context of the Turkish economy, we plotted both variables on the same graph to identify if
this correlation holds from the years 1980 to 2010.
The Phillips Curve theory states that there is an inverse relationship between inflation and unemployment in the short
run (assuming that consumers do not have rational expectations),
3
Spring 2014
20
UChicago Undergraduate Business Journal
Figure 3.1
As seen in Figure 3.1, there appears to be no particular correlation between inflation and the
unemployment rate from the year 2000 to 2010. Specifically, unemployment increases drastically while
inflation rate is stable around 2008, and inflation falls from 2002 to 2004 while unemployment rate is
relatively stable.
Analysis:
As per our predictions and the Phillips Curve theory, inflation/CPI growth appears to have no
correlation with the unemployment rate in the Turkish economy from 2000 to 2010 (Karahan, Colak,
Bolukbasi, 2012). Economists Ozcan Karahan, Olcay, Colak, and Omer Faruk Bolukbasi, who focused on the
Turkish Explicit Inflation Targeting Regime from 2006 to 2011 in their paper ‘Tradeoff between Inflation
and Unemployment in Turkey,’ verify this through sophisticated mathematical computations and empirical
evidence (Karahan, Colak, Bolukbasi, 2012).
For the majority of the past decade, the unemployment rate ranged from 10 to 15% of the total
Turkish labor force, as shown in Figure 3.1. This is attributed to the large-scale privatization and
consolidation of the banking and public sector, where public workers were laid off in an attempt to achieve
greater efficiency in the economy, as discussed in the previous sections. Other factors contributing to high
unemployment rates include burdensome labor regulations, such as very high tax wedges, high minimum
Spring 2014
21
UChicago Undergraduate Business Journal
wages relative to productivity and the necessity to comply with additional regulations such as quotas for
hiring disabled people, ex-convicts etc. (OECD, 2006).
Figure 3.2: Inflation/CPI and Real GDP Growth
Inflation/CPI and real GDP growth are positively correlated but not causally related. As is the
relationship between unemployment and inflation, there is a trade off between inflation and GDP growth in
the short run, as inflation spurs the economy if it is unanticipated, thereby increasing GDP. However, in the
long run, prices adjust, and GDP returns to pre-inflationary levels. Effectively, there is no causal relationship
between GDP and inflation growth.
Figure 3.2
As shown in Figure 3.2, there appears to be no particular correlation between inflation growth and
real GDP growth from 2000 to 2010. Specifically, real GDP growth declines from 2004 to 2008 while
inflation remains relatively stable.
Analysis:
In 2006, the GDP dropped drastically in response to adverse financial developments in the economy.
In fact, Turkey was one of the most adversely affected countries (Ersel, Ozatay, 2008) because foreigners
Spring 2014
22
UChicago Undergraduate Business Journal
maintained large positions in relations to the size of the local market (IMF, 2006). From May to June 2006,
there was a rise in risk aversion among investors due to a fear that “increasing commodity prices, growing
capacity utilization, and tightening labor markets” would accelerate inflation in mature markets (IMF, 2006).
Under the assumption of a closed economy without exports and imports, we would theoretically
expect an increase in inflation during a decline in real GDP growth. This is because a decline in investment
leads to a lower demand for the Turkish Lira, resulting in its depreciation, and thereby making Turkey more
vulnerable to inflation. In fact, the new Turkish Lira in particular weakened by 22% against the US dollar in
the last three weeks of May 2006 (IMF, 2006) because imports became relatively more expensive.
Nevertheless, there was no rise in inflation in 2006. This occurred because the Turkish Central Bank
responded to the sharp depreciation of the Lira and added threat to inflation by raising interesting rates,
which encouraged foreign investors to increase their savings in Turkish banks. As a result, the demand for the
Lira increased, causing its value to appreciate while successfully reigning in the inflation rate. This act
highlights “Turkey’s commitment to achieving its inflation aims” (IMF, 2006). It is also important to note,
however, that Turkey launched its full-fledged inflation-targeting program in 2006, which had further
diminished the threat of inflation.
Figure 3.3: Inflation/CPI and M1: Money Supply
Theoretically, inflation/CPI and money supply are expected to be positively correlated. This is due to
the phenomenon where there exists “too much money chasing after too few goods” (OECD, 2006).
Spring 2014
23
UChicago Undergraduate Business Journal
Figure 3.3
Comparing these two variables on the same graph between the years 1990 and 2010, there appears to
be a particularly sharp increase in M1 growth followed by a sharper decrease of it during the time period of
interest, i.e. from 2004 to 2010. On the other hand, inflation experienced small changes and remained
relatively stable.
Analysis:
The sharp rise in the growth of M1 money supply is owed to the replacement of the Turkish Lira
(The Lira) with the New Turkish Lira (YTL) in January 2005.
This change involved converting every million of the Lira to one YTL. Such a redenomination of
currency helps to restore public confidence through a purely psychological effect (Mosley,2005). This is
because the changes are nominal and hence do not have any real effects on the economy. As discussed in Part
II of the paper, low consumer confidence induces economic agents to use foreign currency, thereby
depreciating the value of the Turkish currency. In light of this and the 2001 crisis, the Turkish Central Bank
(TCB) sought to reduce Turkey’s vulnerability to potential inflationary pressures and threats by removing six
zeroes in the Turkish Lira, reassuring citizens of the Lira’s worth and restoring consumer confidence.
This new currency led to an increase in the printing of money in an attempt to replace the old Lira
bills in the economy. Interestingly, however, although money supply growth spiked in 2005 and reached its
Spring 2014
24
UChicago Undergraduate Business Journal
peak at nearly 85%, inflation growth rate remained very stable throughout these years. The success of this
redenomination lies in its timing. With the right timing, “redenomination caps off high levels of inflation”
(Mosley, 2005). The timing of the redenomination was rather appropriate in the case of Turkey, as the
consumer confidence index had been dwindling until the beginning of 2005. This is revealed by the
Consumer Confidence Graph that will be discussed next.
As for the sharp decline in M1 during 2006, we hypothesize that this was a result of measures taken
by the TCB to ensure price stability. This is because the TCB may have feared that the previous year’s
increase in money supply might have had severe inflationary implications, which could potentially be further
aggravated by the strong depreciation of Lira and the adverse global economic conditions at that point of
time. In fact, the TCB “acknowledged that the 2006 year-end inflation target of 5% (with an uncertainty band
of +/-2%) would not be achieved (OECD, 2006). Hence, the large decline in money growth may have been
in reaction to this expectation or could be seen as a measure that would contain this deviation. One of the
ways in which the TCB went about to reduce the rate of M1 growth was “by abandoning its previous course
of interest rate cuts and raising the short-term policy rate in three consecutive rounds by a total of 425 basis
points, pushing the short-term interest rate up to 17.50%” (OECD, 2006). Higher interest rates correlate with
lower M1 growth rate because higher interest rates encourage savings. This in turn leads to a reduction in the
money multiplier effect4.
Figure 3.4: Inflation/CPI and Consumer Confidence Index
Theoretically, inflation/CPI and consumer confidence are expected to be positively correlated with a
time lag. This suggests that higher GDP, characterized by high inflation, also boosts consumer confidence.
According to Investopedia, the money multiplier effect is the expansion of a country's money supply that results from
banks being able to lend.
4
Spring 2014
25
UChicago Undergraduate Business Journal
Figure 3.4
Juxtaposing both variables on the same graph between the years 2004 and 2012, however, reveals a
negative correlation between inflation and consumer confidence in the context of the Turkish economy. This
could be due to Turkey’s history of consistently high inflation that undermined the political credibility that the
Turkish government and the TCB tried to build.
Analysis:
Figure 4 demonstrates significant fluctuations in consumer confidence between the years of 2004 and
2010: From 2005 to 2007, consumer confidence was rising; from 2007 onwards, consumer confidence fell
sharply.
The reason consumer confidence rose from 2005 to 2007 was the redenomination of the Turkish
Lira in January 2005. As explained in the M1 analysis, this rise in consumer confidence was a manifestation of
consumers’ psychological expectations.
From 2007 to 2008, the large decline in consumer confidence could be attributed to the Turkish
government’s announcement that it had missed its inflation target of 5% (OECD, 2006). This corresponds to
the increase in inflation. While the concept of rational expectations is one of the main factors behind
consumer confidence, other factors such as political instability and terrorism adversely affect consumer
confidence too. In the context of Turkey, these factors include concerns regarding national elections and a
bomb blast in Ankara that claimed 6 lives (BBC, 2012).
Interestingly, during the 2008 global financial crisis, Turkish consumer confidence rose tremendously
until year 2010, exhibiting positive indices throughout. This restoration of consumer confidence stands as
Spring 2014
26
UChicago Undergraduate Business Journal
measure and witness of the 2001 implicit and 2005 full-fledged disinflationary programs’ successes. While
much of the world struggled to adjust and combat the economic crisis, Turkey coped relatively better. The
principal reason was due to policies and initiatives that Turkey implemented, which managed to restore
consumer confidence and eventually curb inflation.
It is also important to note that, recently, consumer confidence has recently declined. As of the end
of 2012, it was at approximately 0.1. There is a lesson to be gained from this: Striving to increase consumer
confidence is insufficient. Concerted efforts are also needed to further cushion the economy from unforeseen
shocks.
As shown by the analysis above, it is challenging to determine a conclusive correlation between
consumer confidence and inflation. This is because consumer confidence is significantly shaped by other
exogenous factors such as political developments.
Figure 3.5: Inflation/CPI and Net Government Debt (% of GDP) & Figure 3.6: Gross External Debt
and National Debt
Theoretically, inflation and debt are positively correlated because debt is usually financed by the
printing of money. Hence, higher debt corresponds to higher money growth and, by extension, higher
inflation growth rates.
Figure 3.5
Spring 2014
27
UChicago Undergraduate Business Journal
This hypothesis is confirmed in the context of the Turkish economy between the years of 2001 and
2010: A steep decline in net government debt (from 75% of GDP in 2001 to approximately 35% in 2010)
corresponds to a large decline in inflation growth.
Figure 3.6
Upon further examination of Turkey’s local and external debt, we find that they are negatively
correlated, particularly so between 2008 and 2012. There are various possible reasons behind these trends,
which we explain and analyze in the Discussion section.
Analysis:
With regards to Figure 5, the positive correlation between net government debt and inflation reflects
the fiscal restraint that the TCB exercised as a part of the structural reforms it pursued in the wake of the
2001 crisis. These reforms involve strictly refraining from printing money in order to enhance the
effectiveness of its disinflationary program.
The negative correlation between Turkey’s local and external debt in Figure 6 suggests that Turkey
may have been financing its debt by borrowing from international agencies such as the IMF. The decline in
local debt further underscores Turkey’s fiscal restraint and commitment to the structural reforms proposed by
Dervis. Moreover, while growing international debt may have its adverse implications, analysis of these
implications on the Turkish economy is beyond the scope of this research. In spite of the increase in
international debt, it is important to note that, in May 2013, Turkey paid its last loan installment to the
International Monetary Fund (Bloomberg, 2013).
Spring 2014
28
UChicago Undergraduate Business Journal
Is Everything As Good As It Seems?
While Turkey has been successful in combating inflation, restoring consumer confidence and
simultaneously ensuring economic growth, is everything as good as it seems?
Upon studying the above graph of income share held by different income groups, categorized in 20
percentiles, it seems that there is a wide disparity in Turkish society. The majority of the income share is
captured by the top 20% group, while the second 20% holds merely around 12% of the income share. The
last 20% has minimal access to income share in the Turkish economy at approximately only 6%. Although
over the years the share of income held by the top 20% has been declining and that held by the other 20%
groups has been rising, the move has been slow.
With regard to other socio-economic indicators, it appears as though one of the most pressing issues
faced by Turkey is the treatment of women and their participation in both politics and the labor force. This
can be owed to patriarchal and cultural factors inherent within the Turkish society (Kasapoglu and Ozerkmen,
2011). Domestic violence in particular seems to be a dominant issue in Turkish society, where police and
courts regularly fail to protect women who have applied for protection orders under the Family Protection
Law (Human Rights Watch, 2012) Another equally pressing issue is the restricted degree of political and
economic freedom in Turkey, and this has manifested itself in the recent protests that have rocked Turkey’s
capital, Istanbul, and the government’s aggressive response to these protests. Now that Turkey has
Spring 2014
29
UChicago Undergraduate Business Journal
successfully subdued the threat of high inflation rates and dwindling consumer confidence, it should focus on
other parameters of welfare in order to fit the bill of a truly robust economy.
Conclusion
After the liberalization of the Turkish economy in early 1980s, Turkey has experienced several
economic crises, the most severe crisis occurring in February 2001. We have shown that the 2001 crisis was
an outcome of the combined effects of economic factors, unsound fiscal policies and structural problems in
the banking industry. This led to a lack of confidence in Turkish economic programs and thus structural
reforms were necessary in an attempt to restore faith in the market. The period directly following the 2001
crisis from 2001-2005 saw the advent of a targeted approach to inflation by heavily reforming the
infrastructure of monetary policy with a focus on restructuring public and financial sectors and balancing the
budget. Implicit in these reforms were measures to increase transparency and accountability of the
government while increasing competition, thus restoring consumer confidence. After this buffer period, the
formal inflation targeting approach was implemented in 2006, which was a continuation of the programs
from 2001, finally stabilizing the inflation rate. This shows the mechanism of the rational expectations model
and how consumer confidence propagates inflation. The success of inflation stabilization can also be owed to
the government’s opportune implementation of its policies and, more importantly, the government’s and
Central Bank’s fiscal discipline and exemplary commitment to its policies in the face of many adversities.
However, now that inflationary pressure has been successfully managed, the Turkish economy should address
other pertinent issues such as high unemployment and other socio-economic factors such as human rights.
Addendum: The Way Forward for Turkey
Turkey’s ability to remain relevant in the future depends considerably on the perception of
sustainability of economic programs, emphasizing the rational expectations model. There are, however,
sufficient reasons to be optimistic about this issue. Having successfully stabilized the inflation rate in Turkey,
future strategies of the Turkish government should place more emphasis on maintaining consumer
confidence, not merely increasing it.
As seen from the graph below, future inflation targets appear stable at approximately 5%. This
suggests that Turkey’s inflation-stabilizing program has been successful in the past and it will continue to
strengthen in the future.
Spring 2014
30
UChicago Undergraduate Business Journal
Spring 2014
31
UChicago Undergraduate Business Journal
Bibliography
"Central Bank of the Republic of Turkey." Central Bank of the Republic of Turkey. N.p., n.d. Web. 02 June 2013.
<http://www.tcmb.gov.tr/yeni/eng/>.
"Current Account (Excludes Exceptional Financing), Net for Turkey (CUAEEFTRQ052N)."Download Data.
N.p., n.d. Web. 03 June 2013.
<http://research.stlouisfed.org/fred2/series/CUAEEFTRQ052N/downloaddata?cid=32344>.
"Dervis Sees Key Role of Politics in IMF Decision." N.p., 12 June 2001. Web. 01 June 2013.
<http://www.hurriyetdailynews.com/default.aspx?pageid=438>.
"Economic Survey of Turkey, 2006." OECD, Oct. 2006. Web. 25 May 2013.
<http://www.oecd.org/eco/surveys/37529636.pdf>.
"EconStats : GDP, Constant Prices | IMF World Economic Outlook." EconStats : GDP, Constant Prices | IMF
World Economic Outlook. N.p., n.d. Web. 03 June 2013. <http://www.econstats.com/weo/V002.htm>.
"Erdogan's IMF Triumph Masks Surge in Private Debt: Turkey Credit." Bloomberg. N.p., n.d. Web. 03 June
2013. <http://www.bloomberg.com/news/2013-05-13/erdogan-s-imf-triumph-masks-surge-inprivate-debt-turkey-credit.html>.
"Exchange Rate to U.S. Dollar for Turkey (FXRATETRA618NUPN)." Download Data. N.p., n.d. Web. 03
June 2013.
<http://research.stlouisfed.org/fred2/series/FXRATETRA618NUPN/downloaddata?cid=33102>.
"Financial Market Update." International Capital Markets Department, Global Markets Analysis Division,
June 2006. Web. 25 May 2013.
<http://www.imf.org/External/Pubs/FT/fmu/eng/2006/0606.PDF>.
"Hourly Earnings: Manufacturing for Turkey (TURHOUREAAISMEI)." Download Data. N.p., n.d. Web. 03
June 2013.
<http://research.stlouisfed.org/fred2/series/TURHOUREAAISMEI/downloaddata?cid=32283>.
"M3 for Turkey (MYAGM3TRM189N)." Download Data. N.p., n.d. Web. 03 June 2013.
<http://research.stlouisfed.org/fred2/series/MYAGM3TRM189N/downloaddata?cid=32344>.
"Strengthening the Turkish Economy- Turkey's Transition Program" Yumpu.com. The Central Bank of the
Republic of Turkey, n.d. Web. 03 June 2013.
<http://www.yumpu.com/en/document/view/12158859/strengthening-the-turkish-economyturkeys-transition-program>.
"Turkey Timeline." BBC News. BBC, 22 Mar. 2012. Web. 01 June 2013.
<http://news.bbc.co.uk/2/hi/europe/country_profiles/1023189.stm>.
"Turkey: HDI Values and Rank Changes in the 2013 Human Development Report." Human Development
Report 2013, n.d. Web. 01 June 2013. <http://hdrstats.undp.org/images/explanations/TUR.pdf>.
Spring 2014
32
UChicago Undergraduate Business Journal
Dervis, Kemal. "Turkey: Return from the Brink, Attempt at Systemic Change and Structural Reform."
DEC/PREM/WBI, 02 July 2003. Web.
<http://info.worldbank.org/etools/docs/voddocs/328/756/turkey_development_dervis_slides.pdf
>.
Ersel, Hasan, and Fatih Ozatay. Inflation Targeting in Turkey. N.p., 24 Oct. 2008. Web. 25 May 2013.
<http://www.femise.org/activites/workshop/Papers/IT_Turkey.pdf>.
Kara, Hakan A. "Turkish Experience With Implicit Inflation Targeting." The Central Bank of the Republic of
Turkey, Sept. 2006. Web. 01 June 2013. <http://www.tcmb.gov.tr/research/discus/WP0603.pdf>.
Karahan, Ozcan, Olcay Colak, and Omer Faruk Bolukbasi. N.p., 13 Sept. 2012. Web. 25 May 2013.
<http://msed.vse.cz/files/2012/Karahan_2012.pdf>.
Kasapoglu, Aytul, and Necmettin Ozerkmen. "Gender Imbalance: The Case of Women's Political
Participation in Turkey." Journal of International Women's Studies 12 (2011): 97-107. Web.
<http://www.bridgew.edu/soas/jiws/vol12_no4/article6.pdf>.
Koch, Levent, and M.A. Chaudhary. "February 2001 Crisis in Turkey: Causes and Consequences." Pakistan
Development Review. (2001): 467–486. Print.
<http://www.pide.org.pk/pdf/PDR/2001/Volume4/467-486.pdf>.
Mosley, Layna. "Dropping Zeros, Gaining Credibility?" N.p., 2005. Web. 25 May 2013.
<http://www.unc.edu/~lmosley/APSA%202005.pdf>.
Ozatay, Fatih, and Guven Sak. "Banking Sector Fragility and Turkey." Brookings Trade Forum. (2002): 121-160.
Web. 3 Jun. 2013.
<http://muse.jhu.edu/journals/brookings_trade_forum/v2002/2002.1ozatay.html>.
Ozkan, F. Gulcin. "Currency and Financial Crises in Turkey 2000 –2001: Bad Fundamentals or Bad Luck?."
World Economy. 28.4 (2005): 541-572. Web. 3 Jun. 2013.
<http://onlinelibrary.wiley.com/doi/10.1111/j.1467-9701.2005.00691.x/full>.
Sargent, Thomas J. The Ends of Big Four Inflations. Tech. no. 158. Minneapolis: University of Minnesota, 1981.
Print.
Uygur, Ercan. "Krizden Krize Turkiye: 2000 Kasim ve 2001 Subat Krizleri." Turkiye Ekonomi Kurumu. (2001):
n. page. Web. 3 Jun. 2013. <http://www.econturk.org/Turkiyeekonomisi/krizdenkrize.pdf>.
Yeldan, Erinc. "BEHIND THE 2000/2001 TURKISH CRISIS: Stability, Credibility, and Governance, for
Whom?." (2002): n. page. Web. 3 Jun. 2013.
<http://www.networkideas.org/feathm/dec2002/Erinc_Paper.pdf>.
Spring 2014
33