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    Is it that hard to go beyond the orthodoxy?

    Fatih Özatay, PhD20 September 2011 - Okunma Sayısı: 734


    The first credit facility Greece used had an interest three points higher than that on German bonds.

    Economic circles of the developed world have started to meet theories brought on mainly by developed country economists, thought to apply more for emerging market economies and thus not interested much in and considered to be outside the fundamental branches of economics. However, some economists, I have to say mainly those in Germany though I do not like generalizations, still are unwilling to become acquainted with these theories. The Bank for International Settlements (BIS), known as the central bank of central banks, organizes several meetings targeted at central bankers. I regularly attended some of those meetings when I was working at the Central Bank of Turkey. The meetings devoted to central bankers at my position were held twice a year. First was for the central banks of Central and Eastern European (ECA) countries including Turkey. Second involved Latin American, Israeli, Saudi Arabian and Tunisian central bankers as well as those of ECA countries. Moreover, all meetings hosted representatives from the European Central Bank and some other international organizations.

    At these meetings, only the participants from the Latin American countries, Turkey and Israel understood each other while the rest could not make sense what the issue is. Majority of Latin American countries and Turkey in particular had dealt with similar problems for years. Israel had dealt with the same problem until the mid-1980s. Let me give an example to make a connection with the current case: In countries which have high public debt and are doubted that they can fulfill the liabilities and thus considered risky, central banks' attempt to increase the interest rate with the aim to tackle inflation might prove counterproductive. Especially if the mentioned step was taken to prevent an increase in the exchange rate due to the shift of economic units from the domestic currency to foreign exchange (FX) as a result of a hike in the risk perception and the resultant inflationary pressures. If the risk perception increased due to the lack of a recovery signal in fiscal policy, it might be impossible for the central bank to prevent shifts to FX by increasing the interest rate. On the contrary, such a move might trigger the demand for FX as it in a way "certifies that things are going downhill". Such a step might in the end push up the exchange rate and thus the inflation rate further. In short, the central bank's efforts to reduce the inflation rate might bring an even higher inflation rate. These all are possibilities; but they can be quite strong under certain circumstances. For instance, this had been the case in Turkey right after the 2001 crisis. And it was difficult to explain the central bankers of developed countries or the representatives of international organizations despite the fact that theories in this direction exists, since Europe had not witnessed such a situation. Unless they did not have a particular interest in those theories, they generally responded, "How's that? How can inflation rate increase when the central bank raises the interest rate?" They probably thought that they misheard and asked the question again. You found peace in meetings in which you express such opinions if Latin officials had also been present. They immediately stepped in and explained how this could happen or had already happened in their country.

    Economic circles in many countries now have started to recall such non-orthodox theories. They understood that they can approach the troubled European economies with the perspective for emerging market economies. However, the mentioned change in the mindsets did not spread everywhere. Take the terms and conditions imposed on the troubled European countries to benefit from the Stability Fund. Those conditions were insisted on mainly by Germany. For example, the troubled countries can borrow with an interest rate higher than that on Germany's bonds. The first credit facility Greece used - in May 2010 if I am not mistaken - had an interest rate three points higher than that on German bonds, for instance. How can a country rebalance its budget while it pays such a high interest for its debt? Second, don't you in a way certify once again that the questioned country is in big trouble by loaning it with such a high interest? I will write more on this "amusing" subject.


    This commentary was published in Radikal daily on 20.09.2011