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    Speed is not always bad

    Fatih Özatay, PhD11 October 2011 - Okunma Sayısı: 971


    The most unpleasant challenge to this type of economic policies is the sudden reversal of the economic circumstances.


    Industrial production index figures for August were announced yesterday. Industrial production decreased month-on-month by 2.6 percent. In July the index increased at the same ratio, recording the only upwards movement in production since February. In January 2011, industrial production increased by 19 percent year-on-year. After this point, the rate of increase decelerated continuously and industrial production recorded a drop by 6.9 percent in July. Annual rate of increase by August was 3.7 percent. In short, annual rate of increase slowed down as widely expected. No more figures are needed; details on the latest developments in industrial production will be covered at length in economics pages of newspapers. I have a different concern about the economic policy implementation process. Excluding the “interesting” ones, economists recommend to introduce measures which stimulate domestic demand in the case that the economy does not fulfill its potential. These measures imply higher public expenditures, lower tax rates and lower interest rates. Of course for these policies to be implemented, the relevant country must not be suffering from high risk perception due to high public debts and high budget deficits. Otherwise, such policies would most likely make things worse. For example, the Greek economy has been contracting for the last four years; but no one has recommended them to increase public expenditures and cut tax rates as such steps would be a complete suicide. Policies of this type must not be implemented in countries which incur high risks associated with fiscal policy. But governments must not hesitate to take steps to increase domestic demand if no such risk exists. This was exactly the case with Turkey at the end of 2008. Domestic demand had come to a halt; risks were not large and existing risks had no relation with budget balance and public debt. Back then in this column, I had written a number of commentaries which suggested that policies that will stimulate domestic demand among others had to be introduced as soon as possible. Those commentaries took departure from the results of a series of reports with numerical analyses prepared by TEPAV.


    The opposite is also applicable. If the economy is growing at a pace beyond its potential, policies that will decrease domestic demand are recommended so that the engine does not get overheated. For instance, in 2010 Turkey grew at a pace high above its potential growth rate. Hiking current account deficit signaled that the engine is about to get overheated. What is more, this high current account deficit was being financed via short-term foreign exchange inflows that could halt at any time. Under these circumstances, the Central Bank of Turkey (CBT) took the lead and took steps to reduce the pace of growth upon a successful determination that rapid credit expansion, one of the chief drivers of high growth, was threatening financial stability.

    A complete reversal

    Whether the aim is to bolster or slow down the economy, the most unpleasant challenge for this type of economic policies is the sudden reversal of the economic circumstances. What would you do if you took steps to cool down the economy, which started to give way to severe problems due to rapid growth, and the change in external circumstances reversed the outlook and you ended up with a growth rate below the potential even before the outcomes of your policy attempts became visible? This is really annoying. What you have to do would be to implement policies in the opposite direction before the outcomes of the previous policy set were received. After all, it is external conditions what we are talking about; you cannot control them. Those external conditions will keep on shaking us as long as Merkel and Sarkozy stay in the office. So, here is the moral of the study: In such circumstances, piecemeal and strung-out measures will not work. "Today (November 2919-April 2010) I (the CBT) will increase the required reserve ratio. Some say that it would not work until the Bank Regulation and Supervision Agency (BRSA) steps in. But who knows, maybe it does. Even if it does not, the BRSA will eventually (in June 2011) step in.” Nevertheless, external conditions necessitated the reversal of those measures only one and a half months after the BRSA stepped in. Conclusion: Speed is good sometimes.


    This commentary was published in Radikal daily on 11.10.2011