Conventional economics (and logic) dictates that the way to bring down inflation is to increase rates. This makes borrowing dearer, limiting growth in the money supply and curtailing spending and investment. Mr Erdogan, however, believes that high rates are not a remedy for inflation, but its cause. “Interest rates are the reason,” he likes to say, “and inflation is the result.” This is enough to make an economist’s hair stand on end. But is there any method to Mr Erdogan’s madness?
Some of Mr Erdogan’s advisers have referred to a theory called neo-Fisherism to show that their boss’s views are grounded in economics. An equation named after Irving Fisher, an early 20th century American economist, defines the real interest rate as the nominal interest set by the central bank, adjusted for inflation. Assuming the real interest rate is determined by economic fundamentals that are fixed, then the equation appears to say that higher nominal rates must lead to higher inflation. Yet most economists view this argument as a mirage–a bit like saying that because government spending is a component of GDP, bigger government will always lead to more prosperity. While nobody disputes the Fisher equation’s definitions, a weighty literature and decades of experience show that neo-Fisherism is no way to run an economy–especially one as unstable as Turkey’s.
Mr Erdogan himself has never brought up the neo-Fisherites. In fact, it is only recently that he has offered any clue as to what shapes his thinking on interest. This seems to be not research, but religion. “As a Muslim, I’ll continue to do what is required by nas,” Mr Erdogan said last December, referring to Islamic teachings, which forbid the receiving or charging of interest. Although he had previously called interest rates “the mother of all evil” and part of the “devil’s triangle”, alongside inflation and exchange rates, this was the first time Mr Erdogan directly alluded to Islam.
The most likely explanation is that Mr Erdogan has come up with his theory more or less on his own. Yet the best way to judge it is not by its roots, but by its results. These have been dismal. Mr Erdogan’s rate cuts caused the Turkish lira to plunge by 44% against the dollar last year and inflation to reach its highest level in two decades. Worse may be to come. Instead of an emergency rate rise that could prevent hyperinflation and offer the currency some breathing room, new rate cuts seem to be in the pipeline. Even without these, inflation might soon top 50%. The real interest rate has reached -16%, meaning Turkish banks are in effect (and generously) paying borrowers to take out new loans. The country’s finance minister, Nureddin Nebati, sounds thrilled. “You’re taking out credit at below inflation,” Mr Nebati reportedly told a group of economists on January 22nd. “We see this as a spectacular success.” Turks, many of whom are struggling to pay for everyday goods as a result of such policies, might not agree.
