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    FED: Then and now (1)

    Fatih Özatay, PhD01 June 2013 - Okunma Sayısı: 798

    If the FED does “now” what it did “then” (in terms of direction and magnitude) what would be the consequences for Turkey?

    In the last couple of weeks Turkey’s interest and exchange rates have increased, due to the expectation that the US Federal Reserve, the FED, will start withdrawing the liquidity generously injected since the beginning of the global crisis and raising the short term policy rate recently around 0-0.25 percent. Benchmark bond rate that was as low as 4.7 percent recently, reached slightly above 6 percent by noon yesterday. Since the beginning of May, the lira value of the Euro-Dollar basket increased by 3.5 percent.

    What’s going on?

    To begin with, I have to stress that this is observed in not only Turkey but all emerging market economies to some extent. But this fact should not relieve us. I think the reason is clear from Turkey’s global crisis experience: during the crisis, Turkey’s economy shrunk and unemployment rate increased significantly. This was the case in all emerging market economies except a few, but this did not put away the problem or give us a relief.

    So, should Turkey be scared of the possibility of FED’s raising interest rates and withdrawing liquidity in the near future? Evidently, such policy reversal will affect Turkey’s economy negatively. But this possibility should not turn into a bogyphobia. After all, it is the magnitude that matters. Then, the key question should be to what degree this policy turn affects Turkey.

    Before elaborating on this, it is useful to go back to yesterday. The FED introduced similar raises in interest rates “then” also and those affected Turkey and its peers. What were the effects? Second, we have to make a distinction between “then” and “how.” The effects we saw “then” do not necessarily surface at all or at the same degree today.

    Then, we must ask: if the FED does “now” what it did “then” (in terms of direction and magnitude) what would be the consequences for Turkey (in terms of direction and magnitude)? To answer this question the first step is to identify the distinct features of the economy then and now. The following questions should be: would the FED to the same now or would the policy be different? How the impact on Turkey differs under these circumstances?

    I will try to answer these questions in the following commentaries, from my perspective. I will pause on this discussion when key figures as inflation or industrial output are released. I am not intending for a long series but a short session of two or three commentaries. All next week.

    This commentary was published in Radikal daily on 01.06.2013