Arshad Shaikh checks the reasons behind the recent fall in the Turkish Lira and the double-digit inflation in the country that was the seat of the Ottoman Empire. He also tries to understand why President Erdogan is not yielding to demands for raising interest rates and insists that it is not all ‘doom and gloom’ as is being presented by the international media.

A quote attributed to Canadian journalist and social critic Linda McQuaig says, “High interest rates focus on the revenue of a parasitic class. Historically the financial system has been structured in favour of moneyed interests, that is, creditors.” President Erdogan’ recipe to cure the Turkish economy is the exact antithesis of conventional monetary economics and goes against the interests of the ‘creditors’ of the world. He is reducing interest rates in the face of rising inflation and the falling Turkish Lira. It is therefore inviting ridicule and derision by everyone save his hardcore supporters.

The typical approach towards inflation (rising prices or too much money chasing fewer goods) is to reduce the money supply by raising interest rates (through the country’s central bank). This appears logical and intuitive. However, Erdoganomics (the unconventional approach of managing the Turkish economy by its President) has a different take on the problem of inflation. It is based on the concept of real interest rates and long-term financial stability.

Can Erdoganomics succeed? The Turkish Lira has lost 46% of its value this year. Exchange rates for free-floating currencies depend on the demand and supply of the currency. The Turkish Central Bank has slashed its policy rate by 400 basis points (4%) since September and inflation has climbed to a three-year high of 21.3%. A lot is at stake including the highest seat of power as Turkey is all set for general elections in 2023 with President Erdogan’s job approval rating at its lowest in six years.


Inflation targeting is a central banking policy that aims to achieve a specific annual rate of inflation. The principle of inflation targeting is based on the premise that for long-term economic growth, we need price stability, which is only possible, if we keep inflation under control. This is achieved using monetary policy tools like interest rates, reserve requirements and open-market operations. One must note that the central bank also has other policy goals like managing currency exchange rates, reducing unemployment and expanding the national income.

The current financial system rests on the foundations of Fractional Reserve Banking. It essentially means that banks keep only a small fraction of deposits (known as bank reserves) with them and the rest is loaned out in the market. That minimum fraction is the reserve ratio. By manipulating the reserve ratio and interest rates of the country’s banking system, the central bank can control the money supply in the market and thus indirectly influence the prices of goods and services. If interest rates are reduced, more people are able to borrow more. Thus, they have more money to spend. This causes the economy to expand and inflation to increase. Conversely, if interest rates are high, people tend to borrow less and spend less. Thus, the economy cools down and inflation reduces. Thus, interest rates become inversely correlated to inflation.


To understand why President Erdogan is so confident of flipping the entire concept of ‘inflation targeting’ on its head will require some explanation regarding nominal interest rates, real interest rates and the relationship between inflation and employment.

Real interest rates are arrived at after discounting for inflation. For example, a bank loans somebody Rs 100,000 to buy a flat at a nominal rate of 10% (this rate does not factor in inflation). Supposing the inflation rate is 6%. The real interest rate the borrower is actually paying the bank is 4%. In economics, this concept is known as the Fisher equation, which states that real interest rate equals nominal interest rate minus the inflation rate. This equation describes how interest rates and expected inflation rates move in tandem.

The real interest rate mirrors the purchasing power of the borrowed money as it grows over time. In an interview to Bloomberg in May 2018, President Erdogan citied the difference in real and nominal interest rates across a spectrum of countries along with their rates of inflation (See Table A).

TABLE AArgentinaRussiaBrazilSouth AfricaTurkeyUSAUK
Nominal Interest Rate40%7.3%6.5%6.5%13.5%1.75%0.5%
Real Interest Rate14.4%4.9%3.7%2.7%2.6%Minus 0.75%Minus 2%

When asked if he favoured ‘zero real interest rates’ i.e. nominal rates matching the rate of inflation, President Erdogan replied: “It would be wrong to assess it as a matter of zero. First of all when you look at the cause and effect relationship, the interest rate is the cause and the inflation is the result. The lower the interest rate is the lower the inflation will be. We need to adjust this well. What is the target in interest rate? It is the real interest rate. Okay, what is the real interest rate? The real interest rate is the difference between interest rate and inflation. The moment you catch this, what do you do with the real interest rate anyway? You take it down in a substantial sense. The moment we take it down to a low level, what will happen to cost inputs? That too will go down. Well as soon as the cost input goes down, you either domestically or in the international market will get the opportunity to sell your products at much lower prices and obtain competitiveness. The matter is as simple as this.”


As of November, the nominal interest rate in Turkey was 15% and expected to reduce further to 12% by 2022. The inflation rate is currently around 16%. This means that the real interest rate is around 1%. If Turkey can manage to record improvements in the current account (it was $2.4 billion in October) boosted by strong exports and tourism and generate a picture of political and economic stability, it is bound to shore up the falling lira in the medium term future.

The key challenge is to generate enough output and ensure its consumption (domestic and international). If Erdogan can manage to pull off low unemployment and real rise in national income in the medium-term, he will have saved the Turkish economy through his heterodox policies. The problem is that no developed economy in the world can operate in isolation and continue to flourish on its own in the long term. It is an interconnected and interdependent global economy that is steered by the interest based global financial system.

An interest based financial system develops two asymmetries. One is the dichotomy between the financial economy and the real economy. The second imbalance is the gross economic inequality that an interest based financial system perpetuates which is the root of all social and financial turmoil.

Former American President Andrew Jackson once said: “If the people only understood the rank injustice of our money and banking system, there would be a revolution by morning”.

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