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    Why don’t we leave the exchange rate on its own feet for now?

    Fatih Özatay, PhD23 August 2011 - Okunma Sayısı: 957


    In the current milieu of high uncertainty, the CBT must refrain from implying preference for a certain level of exchange rate.

    It is for sure possible to evaluate the real value of the domestic currency against foreign currencies (the nominal exchange rate adjusted to the ratio of foreign price level to domestic price level). For instance, there is a point in stating that the Turkish lira is high-valued or low-valued in real terms. The real value of the Lira is of importance for foreign trade. In short, real exchange rate is an important variable. There is no dissensus on this.

    The problem is that, what the economic theory tells about how the value of currency can move to the equilibrium level (not high-valued or low-valued but neutral) automatically or via economic policy proves incorrect. You can check the articles on exchange rate and international macroeconomics text books written in the last three decades to see economists' confessions about this failure.

    "News effects"

    This failure stems mainly from the fact that present expectations about possible future changes affect the future expectations about the exchange rate, influencing the rate today. Expectations about the future interest rate policy of the national or foreign central banks affect the present value of the exchange rate. Similarly, views as to how the domestic and foreign macroeconomic climate will be shaped affect the present value of exchange rate. Domestic and foreign politics and new developments are also influential. There is a complete literature on "news effects".

    If Merkel and Sarkozy had agreed on another policy last week, the value of the Lira against foreign currencies would have been different. Or, if the steps taken to solve the Greek crisis that the world became aware of by the end of 2009 had been taken immediately after the crisis rather than in May 2011, the value of the Lira would have been different. Similarly, if the US economy had not displayed signs of recession again and if the Fed gave the signals of the attempt to increase the interest rate as of the end of 2011, again the value of the Lira would have been different.

    As you might have noted, the points I have mentioned in the above paragraph have to do with external circumstances out of Turkey's control. Exchange rate is an important indicator for countries which traditionally have current account deficits in periods of rapid growth, especially for those which formerly suffered from long-term high inflation and thus citizens used to prefer foreign currency (FX) over the domestic currency. For such countries, that is, for countries like Turkey, exchange is a more critical indicator than it is for other countries. Therefore, it turns important not to speculate and comment on such a critical indicator on which you do not have control in certain periods.

    I worked three years at the CBT with the President. I am also acquainted with him previously from the academia. He is a good person, a good economist and a successful academician. When he was appointed to Presidency, I thought that the CBT was at safe hands. Moreover, the Bank has a well-trained staff. On the other hand, I have harshly criticized the policies of the CBT recently, since I believe that they are making mistakes that do not match with their qualifications. I hope that they consider my words as warnings from a "friend". I have a few more points to stress.

    It is wrong to comment on the exchange rate

    To begin with, in the current climate it is not correct to comment and speculate on the exchange rate. Second, it is even worse to imply preference for a certain level of exchange rate. After all, the CBT issues Turkish Liras, not Dollars or Euros.  In certain periods, you take all measures about FX and Lira to relieve the financial system (such as easing repurchase lending to banks, carrying out regular FX auctions to sell FX, reducing reserve requirements for FX deposits, signing deals with foreign central banks, etc.) Then, you stress that none of these measures are related with the exchange rate and that the sole purpose is to relieve the financial system. Then you leave the exchange rate on its feet, letting it move in the direction it is meant to be.


    This commentary was published in Radikal daily on 23.08.2011