Given Italy's condition, the challenges facing the European Union have grown. In such milieu, caution can be expected in both demand side and supply side.

One way to understand whether the economy has heated up or not is to examine outcomes which might be associated with heating up, as I did last Saturday. Inflation and current account deficit are perfect indicators for such analysis. Particularly the headline inflation that ignores the price movements and current account deficit movements (that is, the current account deficit with constant energy prices) that are not associated with the heating up of the economy prove very useful in this analysis. This second indicator in particular is an important signal for the heating up of the economy.

A second method is to examine the difference between the actual and potential level of production. But there is a problem with this method: potential level of production is not an observable variable; we estimate it. Different estimation methods might give different results. Despite this weakness, however, different studies conducted before the crisis on Turkey reach similar conclusions: Turkey's potential growth rate is around 4.5-5 percent. Some also argue that judging from the structural reforms implemented after the 2001 crisis, potential growth rate might have reached the upper end of this interval.

Has Turkey's potential growth rate possibly increased in the last couple of years? For this, the technology level, the capital stock and the skills and educational attainment of the labor force must be more superior to those over the period in which the potential growth rate was calculated to be 4.5-5 percent. This cannot happen overnight, and I do not remember any structural reforms that could achieve such enhancement in the recent years. This brief debate implies that the potential growth rate of Turkey has not increased. In the light of this estimation, you can diagnose that the Turkish economy has heated up significantly. The latest growth figures are for the first quarter of 2011. There also are some indicators for the second quarter. On the other hand, the latest available inflation data is in June and current account deficit data is in May. The figures for the following months are of higher significance. Therefore, the heating up can be analyzed within a third perspective: potential future movements. In this context, two things must be kept in mind.

First, the Central Bank of Turkey (the CBT) beginning from the late 2010 and the Banking Regulation and Supervision Agency (BRSA) after the elections started to introduce some decisions to slow down the rapid expansion in both credit supply and demand. The CBT decisions taken before the BRSA's intervention were not very successful, concerning the heating up of the economy. As the latter stepped in just recently, we have to wait to see the results. But I have to stress that the BRSA decisions might not be as successful as desired in reducing the credit demand. Interest on consumer loans have increased considerably following the BRSA decisions. However, this does not cause a substantial increase in the monthly payments since the total loan amounts are low compared to housing loans. Moreover, latest data maintain that the rise in the credit demand did not slowdown yet. Secondly, global uncertainties are rising. Given Italy's condition, the challenges facing the European Union have grown. In such milieu, caution can be expected in both demand side and supply side. Let's hope that.

This commentary was published in Radikal daily on 19.07.2011