Policy rate hike critical to lower inflation

Professor of Economics at Harvard PROF. DR. KENNET ROGOFF,

University and Former Chief Economist at the International Monetary Fund (IMF) answered questions about inflation from daily DUNYA.

TURKEY IS ONE OF THE HARDEST HIT ECONOMIES BY THE WAR IN UKRAINE. WHAT IMPACTS SHOULD WE EXPECT?

The uneven post-pandemic recovery, combined with the prospect of a sustained rise in US interest rates, almost guarantees that there is going to be a spike in emerging market financial crises over the next two years, meaning with a debt default, a banking crisis, or both. So far, the countries under greatest duress have been developing economies and low-income emerging markets. However, thanks to a very high degree of fiscal/political dominance that has grotesquely undermined central bank independence, Turkey too has been on the watch list even before Ukraine. Now, the risks are even greater, partly because the risks of recession in Europe are much higher, partly because the war generates substantial uncertainty, and partly because some of Turkey’s important trading partners are at risk.

WHAT ABOUT US AND EU EFFORTS TO CONTROL INFLATION AND THEIR POTENTIAL IMPACTS ON TURKEY?

The US is almost certainly well past the point where inflation can be brought down in 12-18 months without a recession. Europe, and especially Germany and Italy, are at great risk of recession if further sanctions lead to a cutoff of Russian energy supplies. Even without further escalation in sanctions, Europe is now set to have much slower growth (1.5 to 2% lower) that it would have otherwise. Recession in Turkey’s essential trade partners will be negative for its export revenues and current account balance. Yes, it is virtually impossible for Turkey to avoid a sharp slowdown if there is war going on nearby, and major trading partners are in recession.

WHAT STRATEGY SHOULD TURKEY FOLLOW IN ITS FIGHT WITH INFLATION?

At this point, it is very difficult drive down inflation without sharply raising interest rates. And unfortunately, because of the failure to raise interest rates earlier, and the credibility the government has squandered by repeatedly firing central bank governors, it is going to be painful indeed to restore lower inflation. Unfortunately, Turkey could be headed for a worse economic crisis than it had twenty years ago. Though, there is still time to avoid a hard crash landing of the economy, as the overall global growth and interest rate environment is sufficiently benign even with the war so far.