A Precarious Balancing Act
Turkey’s quest for a strong Lira and its potential ramifications
COVID-19’s effects are semi-universal and almost innumerable, and entire economies were shutdown to contain it. In doing so the weaknesses of many economies, including Turkey’s, became apparent. More specifically, COVID’s onslaught led to a drastic fall in the Lira. This time last year, the Lira was trading at 6.06 Lira per dollar, and now it is trading at 8.36 Lira per dollar. For Turkey, this depreciation could not come at a worse time. Turkey is a country that consistently imports more than it exports and has a floating exchange rate, so having a less valuable currency implies being able to afford fewer imports.
In an effort to ease COVID-19’s economic difficulties, the Turkish government injected more money into the economy via cheaper loans from state-run banks. However, this injection had the effect of depreciating the Lira since there was more Lira to go around. However, Turkey’s Lira woes are not exclusively caused by the response to COVID-19. Erdogan’s tough rhetoric against France and Turkey’s assertive foreign policy in Syria and the Eastern Mediterranean may be a cause of some of the issues due to the economic uncertainty caused by international backlash. Thus, it is difficult to find one panacea to Turkey’s currency issues. Nevertheless, selling government bonds in exchange for Lira (also called open market sales) may help appreciate the Lira.
The logic behind open market sales is that more bonds and fewer Lira in the market would decrease the price of bonds. This is then expected to increase country-wide interest rates. Higher interest rates incentivize more investment in Turkey, which would ultimately appreciate the Lira relative to other foreign currencies. Given enough time and stability in the amount of Lira, the novelty of the policy will wear off and the economy will begin to stabilize through a drop in price levels.
While theoretically sound, opaque open market sales may jeopardize other parts of the economy since COVID-19 can obfuscate the economy’s true nature. Milton Friedman asserts that a common consequence of monetary policy is the warping of work decisions, which may be influenced by not knowing whether the change in wages was caused by a price level change or a change in the demand for labour. In the case of a lower supply of money, the decrease in price levels may lead some workers to the conclusion that the real value of their labour has dropped, which can push them to work less or even choose to rely on government benefits. This ultimately means that production will be lower than before, which is not desirable given Turkey’s economic difficulties. Therefore, Turkish monetary actions should be cautious and geared towards stability.
Indeed, Erdogan previously tried to increase confidence by pledging “price, monetary, and fiscal stability”, which led to a 3% increase in the Lira. However, his firing of the central bank chief in late March, the Lira plunged once more. Overall, Turkey should tread lightly in its economic actions, for as Friedrich Hayek said, “the curious task of economics is to demonstrate to men how little they really know about what they imagine they can design.”
