The recent interest rate decision was generally misinterpreted. It was said that the CBRT (Central Bank of Republic of Turkey) cut interest rates and comments that might damage the prestige of the Bank was made. However the CBRT did not change the policy interest rate. False and wrong comments were made upon the CBRT's cutting bank borrowing rate.

Let us assume that the short term reserves banks hold for some reason are collected at a pool. Let us call this 'daily water usage pool' for now. Until recently, this pool used to flood. And the CBRT drew water from the pool so that the flood does not damage around (inflation) and paid a price for the water it drew. The technical term for this price is 'borrowing interest rate'.

However now there is no water in the daily water usage pool. There is only one institution that can put water in the pool for daily usage: the CBRT. Nowadays the CBRT transfers water to the pool and claims a 'service cost' from banks in exchange. The technical term for this cost is 'repurchase rate'.

Therefore, until recently it was the water drawing price (borrowing rate) that was important for the banking system and the economy as a whole. But now since there is no water in the pool, it is the water transfer cost (repurchase rate) that is important. The CBRT did not change the repurchase rate but reduced the borrowing rate by 0.25 points. But why did the Bank made this move though there is no water in the pool?

The real story goes like this: in fact, there is no single pool. Every bank has its own pool. Some has water in it while some does not. Under normal conditions owners of the pool that has no water rent water from their neighbors with water in their pool and return it the day after. If, after this transaction, the sufficient amount of water is not collected, the CBRT carries out the mentioned transfer.

If financial markets are in tension, owners of pools filled with water may be unwilling to transfer water to owners of empty pools since they might need the water the day after. They might be afraid that the water they lend for a limited time does not come back. And they sell the water to the CBRT so that they can earn interest since it is definite that the water will be returned.

It is this rate that the CBRT cut. This way, he tells the owners of pools with water: 'Now you will learn less when you sell your water to me. But you can charge higher prices from the water if you sell it to needy banks.' The Bank asks those which have water to lend it to those which does not. It wishes that the pooling system works as it does under normal conditions.

The point of importance for policy rate is this: Nowadays there are a limited number of pools. The water is not sufficient to quench the thirst of other pools. Thus, the system needs the water the CBRT can transfer. What is more, the CBRT ensures that the transactions it does in the big pool and the price of water purchase and sale between small pool owners take place at a level close to the level it desires. That level is 7% and it was not altered.

And here is the funny part: The CBRT has declared on April 14 that it will initiate this decision. And a number of false comments that will damage the prestige of the Bank were made, anyway.

This commentary was published in Radikal daily on 19.09.2010