Question

A recent Financial Times article entitled “Turkish Business Association Calls for Central Bank Independence” summarizes a report from the Turkish Industry and Business Association, which criticizes recent central bank policy.  According to the article:

“The country’s nominally independent central bank, which has come under continued pressure from [Turkish President] Erdogan to keep rates low despite high inflation, is expected to cut rates again when it meets on Thursday [October 21^st]. Last month the bank slashed its benchmark interest rate to 18 percent even as annual inflation rose to more than 19 percent.” 

President Erdogan also fired several central bank officials who disagreed with the September interest rate cuts.

a.      According to a speech by President Erdogan in January 2021, he believed it was impossible for Turkey to reduce inflation toward target values when interest rates were high.  He reportedly pressured the Turkish central bank to reduce interest rates to reduce inflation.  Why was he mistaken that lower interest rates would lead to disinflation?  How does this relate to the real interest rate in Turkey?  You may want to use a model of your choice to explain.  

 

b.     The Turkish central bank’s (Türkiye Cumhuriyet Merkez Bankası) position toward inflation seems weak as inflation continues to rise in Turkey.  Please explain how inflation could continue to rise in Turkey unless central bank policy changes.  Is there a limit to the inflation increase in the worst-case scenario?  What would you do to stop inflation?  You may want to use a model of your choice to explain.