Turkish Monetary Policy (and Currency Wars, the Fed, Central Banking and Other Stuff)
I know, I know… Not the most exciting topic, but that’s where all the questions for me are coming from for the past two weeks, and that’s what I’ve been writing about in my Huriyet Daily News columns. So I intend to talk about Turkish monetary policy by taking those columns as base and then expanding on them. So here we go:
That was my reaction when I read Economy Minister Zafer Çağlayan’s written statement after the second-quarter growth figures were released last Monday.
Here’s the intro. to my Hurriyet Daily News (HDN) column from the week before last, with a title inspired by Feynman’s (fine man!) famous memoir. I take Turkish Economy Minister Zafer Caglayan’s (aka The Admiral, see column for why) response to the latest growth figures as starting point, and I discuss the most recent Turkish data & the monetary policy response.
First, I show that, contrary to what Caglayan is saying, monetary policy is not tight at all. In fact, Prime Minister (PM) Recep Tayyip Erdogan argued on TV on Wednesday that interest rates were high, which I refute in the column by showing real rates. BTW, I’ll come back to Erdogan’s interview below, as he made other econ. remarks as well.
I then discuss Caglayan’s other claim: The current account is improving, not because exports are going very strong, as he argues, but because they are performing just a bit better than imports, whose slowdown should be attributed to the slowdown in the economy. Anyway, you can read the details in the column.
I also mentioned in the column that the Central Bank was widely expected to cut its lending rate by 50-100 basis points (bp). The Central Bank ended up cutting 150 bp, slightly more than expected, but not a game changer. More interesting was the emergence of its new tool, Reserve Option Coefficients (ROCs), as a major policy tool, which brings us to this week’s column:
During a speech on Friday, Central Bank Governor Erdem Başçı underlined that it would take a (brave) heart to implement the Bank’s latest tool, Reserve Option Coefficients (ROCs).
Here’s the intro. to that column, and you can read the whole thing at the HDN website. I decided to start with Basci’s remark for two reasons. It made for a great title:), but I also wanted to make a specific point. But I could not make that point before explaining ROCs, so I spent a good deal of the column on what ROCs are, and if they will work
Just a bit of taxonomy: You don’t have to feel ashamed if you are hearing the word ROC for the first time: It is a Central Bank of Turkey invention- the CBT claims the methodology is its invention as well, and I’ll come to that later, but the word is definitely theirs: In fact, when they first started the new system at the end of May, they weren’t calling it ROC; they used the word for the first time after the August Monetary Policy Committee (MPC) meeting. But after last week’s meeting, they went a step further by naming the title of their short note “Press Release on Raising the Reserve Option Coefficients”. So the Bank has gradually increased the importance it attaches to the ROCs, so I would call this good communication on the Bank’s part (more on communication below)- I would have liked it better if they made their intentions to use ROCs more right from the start rather than introducing it as a side dish at first gradually making it the main course.
As for whether the ROC itself is the Bank’s own invention: There is an IMF paper from 2011 that refers not to ROCs per se, but the fact that you can play with the currency composition of reserves. I was told by Turkey Data Monitor’s Murat Ucer that there is actually a literature from the 80s that makes the same point- so Gary, the author of the IMF paper, was merely bringing them back to life, it seems. The same goes from the Bank’s other copyright claim, the interest rate corridor: There is variant of it in Mishkin’s well-known textbook as well as Hubbard and O’Brien’s Money & Banking textbook (pages 447-448). But at the end of the day, it really doesn’t matter who invented it first, but I don’t think the Bank’s emphasis on being original is helping its cause. After all, Central Banks are supposed to be boring; I think it would comfort people more if the Bank did not focus so much on innovation. [Just a small note/diversion. whatever you want to call it: Yep, this is "the Hubbard" in the documentary Inside Job. And BTW, Mishkin's Icelandic adventures are discussed there as well. What is up with these money/banking textbook writers?:)]
And that brings me to my general criticism of the Central Bank: I may disagree with some of the Bank’s policies, but if I would easily choose their views over mine: After all, they have a staff of several dozen Econ. Phds in their Research Department, who have access to much more information, from the government and markets, than I do. BUT provided that they support their claims. Unfortunately, the Bank rarely does that, and there are several instances over the past couple of years where they have made bold claims without supporting them- I discuss a specific example in a post from last year. I am not expecting AER papers from them, but at least a working paper or even a short note. [another small footnote: The Fed is criticized by some because of the consequences of its QE3 are not clear. I have to sympathize with them and the CBT, as they threading water in uncharted territory, but still I'd expect a bit more rigor from the CBT. As for the Fed, there are more qualified people to discuss monetary policy here at Economonitor, but here are a couple of links: Simon Johnson discusses restoring the legitimacy of the Fed while James Bullard of Fed St.Louis argues, as a response to the critics, that patience is needed for the Fed's dual mandate]
The same goes for ROCs. In the column, I argue that ROCs could increase banks’ foreign borrowing. I may be wrong; it could be that banks would borrow that money in any case, and that the CBT is just changing how banks will borrow that money (in London via swaps versus through the Central Bank), but I’d need to see formal argument for that. You may say I don’t support my claims rigorously, either- which is fine, as I am a mere columnist, not the monetary policy authority.
My second big criticism is related transparency. That has been a problem since the Bank began with its unorthodox policy about two years ago, but for the case at hand, the reasons given in the post-MPC one-pagers for the purpose of ROCs are somewhat different from the ones given by Basci during his speech last Friday.
Another problem has been simplicity: The Bank’s policies can be confusing at times. To give another recent example, if your friendly neighborhood economist, a well-known Turkey economist and two central bankers are struggling to see why a central bank should not be paying interest on reserves to implement ROCs, the policy is not simple, period!
Moving on, there were some very important points in Basci’s speech, which I could not discuss due to, as usual, space limits. While you can read all the details in my friend Ozlem’s research note, one huge point many missed were his remarks that the Bank would tie internal to external demand; i.e. it would loosen monetary policy and let domestic demand increase as long as exports improved. Which makes sense, as the current account deficit would not get out of control. But again my point on transparency & clarity: What is the exact relationship between the two in the Bank’s mind?
Still moving on, I did not have a chance to talk about the currency and other market implications of the ROCs in the column, either. I had a sentence or two on FX, which I had to throw out due to space constraints: “Incidentally, the currency won’t be affected significantly as long as funds are coming from abroad. At the other extreme, if banks were to collect FX domestically or give up their own funds, the lira would weaken.” As for other asset implications, BNP Paribas had a thing or two to say on the asset-swaps:
Currently the 10Y ASW basis at 214bps is one of the highest since April. We think such levels are appropriate to build positions, as the QE measures from developed market central banks will eventually add to the FX liquidity at home and lead to significant contraction there in the medium term. In the short-term we expect contraction towards 180bps. Another way to play this is at buying shorter maturity 2Y benchmark bonds, against 6m FX forwards. Currently this yields 230bps and we think a contraction towards 170bps is likely.
My final additional point is on the bigger picture, i.e. the forest rather than the trees. After all, I don’t want to sound like a provincial economist unaware of global developments. Fed’s QE3 have raised fears global currency wars (or here or here for a non-paywall version). Brazil’s outspoken Finance Minister Montega (he reminds me of Zafer Caglayan) was rather critical, and countries like Peru, Chile, Brazil and others were pondering on how to respond to a new wave of hot money threatening to appreciate their currencies and destabilize their balance of payments- RBS even has a battle plan for the Bank of Japan . So you may see the ROCs as the CBT’s move in the currency wars, but note also that some economists believe QE3 should not result in such strong flows to EMs- and a similar argument has been made for the ECB’s bond buying as well.
Coming back to the Bank’s rate cut and Caglayan: The Admiral was obviously not very happy with the Bank’s rate cut, as he was emphasizing the Bank should have cut the one-week rate as well. Basci underlined under what conditions the Bank would actually cut that rate during Friday’s speech. He mentioned three pre-conditions: 1. Severe global recession 2.Significant lira appreciation and 3.Rapid disinflation that would drive inflation below the 5% target. Since none of these is likely at the moment, we can rule that out for now. But Basci’s Friday speech and the tax hikes announced this week brought out some important divisions in the direction of economic policymaking in the government. I am sure you are dying to read that, but this post has already been quite long.
And besides, that is the subject of my column for next week, so you just have wait just two days; my Daily News column will be published at 17.00 EST on Sunday…
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