Turkey's Election and the Unorthodox Economics of Erdogan

Cutting interest rates during high inflation is an unorthodox policy that most economists believe worsens inflation.

Erdogan argues that lower rates will boost growth and exports, claiming "if the lira loses value against the dollar, Turkey's exports will simply become cheaper and foreign consumers will want to buy even more of them" and "as the interest rates go down, so will inflation."

Why: Conventional economic theory holds that higher rates reduce money supply and demand, thereby cooling inflation. Erdogan's Islamic economics-based view that interest is "the mother and father of all evil" contradicts this consensus.

"Erdogan's unconventional economic theory is rooted in Islamic economics and he has invoked Islamic precepts against usury and referred to interest on loans as the mother and father of all evil to justify his actions."

Spending foreign reserves to prop up a falling currency squanders national wealth for temporary effects.

Turkey spent $7.6 billion in one week alone supporting the lira, with reserves declining $17 billion (15%) in six weeks before the election. The government has also restricted foreign currency purchases and created special lira savings accounts.

Why: Currency interventions only work while reserves last and don't address underlying economic imbalances. Once reserves are exhausted, the currency typically falls further.

"it makes no sense to spend a country's valuable foreign exchange to pump up the value of a falling local currency, as while it might work in the very short term, you are squandering the wealth of the nation for a temporary effect that disappears as soon as you run out of foreign exchange"

Pre-election spending promises create fiscal obligations that constrain future policy regardless of who wins.

Erdogan raised minimum wages repeatedly, provided free natural gas, reduced electricity prices, increased civil servants' salaries, allowed early pensions, and gave 45% pay rises to 700,000 public workers. "All of those commitments will need to be honoured by whomever wins the election."

Why: Such spending increases budget deficits and inflationary pressures, limiting the winner's ability to implement reforms.

"All of those commitments will need to be honoured by whomever wins the election, meaning that greater government spending can be expected one way or another."

Relying on politically-motivated foreign financing creates complex repayment obligations and uncertain terms.

Turkey has received $5 billion from Saudi Arabia, delayed gas payments to Russia, and arranged swap agreements with Qatar and others. "The terms of many of these agreements with other countries have not been made public and paying back many of these political favors may become complex in the future."

Why: Political loans often come with unstated conditions and may not be renewable, creating rollover risks.

"The terms of many of these agreements with other countries have not been made public and paying back many of these political favors may become complex in the future"

Turkey's past shows that independent central banks and tight fiscal policy can control high inflation.

From 1975-2004, Turkey suffered chronic inflation from political instability and poor institutions. "The establishment of an independent central bank in 2001, which focused mainly on fighting inflation along with tight fiscal policies implemented at the same time, brought inflation under control."

Why: Institutional independence from political interference allows central banks to make difficult but necessary decisions to maintain price stability.

"The establishment of an independent central bank in 2001, which focused mainly on fighting inflation along with tight fiscal policies implemented at the same time, brought inflation under control."

Turkey's core economic strengths remain despite policy mistakes - diversified economy, good demographics, educated workforce.

Turkey transformed from low-income to upper-middle-income under Erdogan's first decade, became 12th largest economy by GDP in 2020. "The country mostly just needs a sensible interest rate policy and an independent central bank."

Why: Strong fundamentals mean recovery is possible with policy correction, unlike basket-case economies.

"Turkey has a lot of positives, it has a diversified economy, growth is good, it has good demographics and an educated workforce."

Official inflation statistics may significantly understate true price increases during economic stress.

Official Turkish inflation was 43.7% in April (down from 80%), but "widespread suspicion that the official numbers understate an inflation rate that according to independent experts is actually closer to 100%."

Why: Governments facing elections have incentives to report favorable data, making independent verification crucial.

"There is, in fact, widespread suspicion that the official numbers understate an inflation rate that according to independent experts is actually closer to 100%."

Leaders may pivot to orthodox policies after elections despite campaign rhetoric, but face political costs.

Adam Tooze suggests Erdogan might pivot like Xi Jinping did on zero-COVID. "The difficulty for Erdogan is that pivoting from low to high interest rates will also hurt but it will hurt a different group of people than were hurt by low rates and inflation."

Why: Different economic policies create winners and losers; changing course requires managing political constituencies.

"The difficulty for Erdogan is that pivoting from low to high interest rates will also hurt but it will hurt a different group of people than were hurt by low rates and inflation. This might be politically difficult to do."