Expectations play a crucial role in macroeconomic models and in financial markets. If policymakers are not trusted to take the necessary measures in the future, even if they are doing the right thing now, consumers, firms and investors will take fright. The belief that central banks are unwilling or unable to deal with inflation, for example, will lead households to move their money out of the currency to prevent losing the value of their savings. Firms will price in the expectation of further large increases in costs, perpetuating the cycle. In both Turkey and Argentina, there is a reason to fear for the path of policy. In Turkey this is a familiar story by now: President Erdogan is vehemently opposed to more conventional monetary policy and to that end has leaned on the Central Bank on repeated occasions. That the Central Bank has been stepping away from a previous commitment to tighter interest rate policy, despite the pressure on the currency, served as an affirmation of this perception.
The appointment of his son-in-law as finance minister also did nothing to assuage market fears, particularly after lackluster PowerPoint presentations, most recently at the IMF meetings. There is little sign so far that policy will take the right direction in Turkey. In Argentina this is something of a new tune, at least under the current president. President Macri was elected on an economically traditional reform agenda, initially cheered by markets. However, the turnaround has taken longer than expected, and the electorate have begun to tire of promises of jam tomorrow. Former President Cristina Fernández de Kirchner has begun to climb in the polls, with elections due this October. The return of Kirchner, and populist policy, seems an increasingly real threat. Political challenges for Turkey and Argentina then are clearly significant, if not insurmountable. The good news for the rest of EM though is that this is very clearly a country-specific risk, and there is little reason for it to lead to contagion beyond the hit to general EM investor sentiment. (May 3)