The fallacy of Erdogan's interest inflation theory
President Erdogan's recent assertion that "interest is the cause, inflation is the result," and his attempt to ascribe a religious basis to this notion has sparked widespread debate. While the spiritual implications of such a claim in a constitutionally secular state raise serious concerns, it is equally important to examine the practical economic impact of this theory. By analyzing the contrasting experiences of Turkey, the United States, and the European Union, we can better understand the effect of interest rate policy on inflation and discern the validity of Erdogan's bold claim.
The Turkish case: A Tale of misguided policy
In October 2021, the Central Bank of Turkey's policy rate stood at a staggering 24 percent, while the inflation rate hovered around 15 percent. During this period, the perplexing theory of "interest rate is the cause, inflation is the result" came into play. In an unexpected move, the central bank slashed its benchmark interest rate to 8.5 percent, only to witness a rapid rise in inflation, which soared to nearly eighty percent by early 2022. Erdogan's assertion was borne out, albeit counterintuitively; cutting interest rates led to an astronomical rise in inflation. This turn of events underscored the fallacy of his theory and revealed that lowering interest rates can trigger a surge in inflation.
The U.S. experience: A Triumph of prudent policy
In contrast, the United States has been grappling with its inflationary challenges. In 2021, the country's inflation rate reached an uncomfortable 4.7 percent, despite maintaining a zero percent interest rate. In response, the Federal Reserve (FED) took a firm and disciplined approach, raising interest rates to curb inflation. Initially, the inflation rate resisted the rate hikes, but the FED's steadfast commitment eventually bore fruit. As of June 2023, the FED's benchmark interest rate is 5.5 percent, and annual inflation has fallen to 3 percent. The U.S. experience is a compelling case against Erdogan's theory, demonstrating that measured interest rate increases can effectively combat inflation without plunging the economy into recession.
The European Union's lesson: Incremental steps to stability
A similar story unfolds within the European Union (E.U.). In 2021, the E.U.'s central bank maintained a zero percent interest rate, as did the United States and Turkey. However, as inflation rose, the E.U. Central Bank opted for more cautious interest rate adjustments, albeit less aggressive than the FED's approach. The E.U.'s inflation rate climbed from 2.9 percent in 2021 to a worrying 9.2 percent in 2022, prompting the bank to raise interest rates gradually. The annual inflation rate is 5.5 percent, and the interest rate has risen from an initial zero percent in 2021 to 3.5 percent. Notably, some E.U. member states, such as France, have managed to keep their inflation rates even lower, at 4.3 percent. The E.U.'s experience further invalidates Erdogan's theory, underscoring that prudent and calibrated interest rate adjustments are crucial to controlling inflation.
Orthodoxy prevails, a stark contrast
A clear pattern emerges when we examine the divergent paths of Turkey, the U.S., and the E.U. Both the U.S. and the E.U. have succeeded in taming inflation by adopting scientifically orthodox interest rate policies. Their successes directly challenge Erdogan's theory, which has led to misguided policy decisions and exacerbated inflationary pressures in Turkey.
In contrast to these triumphs, inflation in Turkey continues to loom large, with double-digit figures expected shortly. The disparity between countries implementing prudent policies and those pursuing untested theories is stark.
In conclusion, the experiences of Turkey, the U.S., and the E.U. provide a compelling case against President Erdogan's "interest is the cause; inflation is the result" theory. The path to taming inflation lies not in unsubstantiated claims but in carefully calibrating interest rates based on sound economic principles. The lessons from these economies underscore the importance of evidence-based policymaking and serve as a cautionary tale against embracing theories that lack empirical validation.