Addendum to HDN column: The Admiral has sunk
Here’s the promised addendum. Let me start with the most important item, real exchange decomposition. My apologies to my readers who are professional economists; you may skip this section and read the rest of the addendum:
The real exchange rate, q, is often written like this: q= p/ep*, where p is the domestic price, e the nominal exchange rate and p* the world price. Note that when you write it like this, an increase is an appreciation; I like to write it upside down, but I am sticking to the Central Bank’s notation. Intuitively,the denominator is world prices in your own currency, so you are in effect comparing domestic and world prices in your own currency.
Anyway, once you take logs and time derivatives (you have to trust me on this one), you are left with: the growth in real exchange rate is equal t0 the growth of domestic prices- growth of nominal exchange rate – growth in world prices. But the growth in prices is just inflation so, we have: RER growth= (domestic inflation – world inflation) – growth in inflation.
Now, we are done with the math, so let’s first define what this means: RER appreciation is equal to the inflation differential between your country and other countries (whoever you are comparing your country to)- exchange rate depreciation (between your currency and the country you are comparing to). This is theory, but in practice, this is a tedious process: Let’s say you are looking at Turkish RER vis-a-vis developed countries: You’d need to weigh their inflations and exchange rates versus the lira by the share of each country in Turkey’s trade; that’s what the real effective exchange rate, or REER is.
So that’s why I was doing in the second graph. Acute readers will notice I don’t have world inflation there. Unfortunately, Turkey Data Monitor does not have other countries’ inflation rates; otherwise, it would have been called World Data Monitor:), but including those would have made my case even stronger, as most developed countries had very low inflations during lira’s real appreciation period of 2009-2010.
Anyway, going on with other matters: This is another column where I wish I had more space, as Caglayan had more interesting things to say. For example, look at this excerpt from the Daily News article:
The economy minister also touched upon comments by foreign media and rating agencies, such as The Economist, Moody’s and Financial Times, regarding the country’s current account deficit, about a week before the June 12th general elections. “These institutions’ aim is to disturb Turkey’s balances, to make it once more a borrowing country, and then suck its blood by hiking up interest rates.”
This statement assumes that the ratings agencies and the press are servants of the finance sector. I think the Minister, used to his government’s preferential treatment by government-friendly dailies such as Sabah, Zaman, its English-language counterpart Today’s Zaman and the like, thinks it works the same way in the Western media. It doesn’t! He is also assuming all the finance community has a single position on Turkey. If these institutions’ aims were indeed to suck Turkey’s blood by hiking interest rates, many foreign financiers would lose as well, especially all those foreigners who own nearly 2/3 of Turkey’s stock market. Anyway, feel free to look at the detailed coverage in the Association of Economy Journalists website if you speak Turkish.
Finally, I would like to address some reader criticism. Reader @babadog, commenting at the Daily News website, says the following:
Imports are mostly energy which we must substitute for ASAP with renewable energy sources and nuclear but your analysis isn so right Emre!!
I am not sure what else she has found fault with my analysis, but let me say a word or two about the energy business. It is true that energy imports make a bulk of Turkey’s imports (42 percent at the moment), but the non-energy current account deficit has exploded recently as well:
This should not undermine the importance of making Turkey energy-dependent, but the source of Turkey’s exploding current account deficit is not energy alone. We need to know the symptoms well in order to make accurate policy recommendations.
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