A Cautionary Turkish Economic Tale

Having worked on emerging markets for many years, first at the IMF and then on Wall Street, I can recognize an economy on the road to a crisis. It pains me to say that the United States appears to be now treading the familiar path that recently got an emerging market economy like Turkey into deep economic trouble. Like Turkey, the United States is increasingly disregarding central bank independence, persistently running large external current account deficits, continually running large budget deficits, and is starting to disregard the rule of law.

Turkey's economic policy mistakes have led to excessive inflation, major currency weakness, and disappointing economic growth performance. The Trump administration would do well to study Turkey's economic experience over the past decade, if it is to avoid the economic mistakes that got that country into deep trouble.

A principal factor in Turkey's poor economic performance over the past decade was President Erdogan's misguided belief that interest rates were the cause of rather than the cure for inflation. This induced him to lean heavily on the Central Bank of Turkey to cut interest rates even at a time when inflation was rising. He did so by firing a succession of central bank presidents and by appointing a central bank board that totally complied with his desire for low interest rates.

It was only when inflation soared to 85 percent and when the Turkish lira was in free fall that Erdogan was forced to make an abrupt monetary policy U-turn. He appointed an orthodox and respected person to head the central bank and allowed her to raise interest rates from 8.5 percent in early 2023 to 50 percent by March 2024. In response, Turkish inflation has started to come down sharply.

Seemingly oblivious to Turkey's sad inflation story, Trump is now leaning heavily on Federal Reserve Chairman Jerome Powell to cut interest rates by between one and two percentage points. He is doing so even at a time when inflation remains above the Fed's two percent inflation target. He also openly talks of his desire to replace Powell and the rest of the Fed board with monetary policy doves as soon as their terms expire. As if this were not enough to undermine the Fed's independence, he is also toying with the idea of soon naming Powell's successor well before Powell's term expires in May next year.

Like Turkey, the United States has been running persistently large external current account deficits and it has a very large external debt. This makes its currency vulnerable to downward movements in response to monetary or budget policy missteps. It seems to be no coincidence that the US dollar has dropped by around 10 percent since the start of the year as markets have begun to question the United States' commitment to keeping inflation under control. The dollar's recent decline is all the more worrying considering that it has been occurring even when one would have expected the dollar to appreciate in response to sharply higher import tariffs and a widening short-term interest rate differential in the United States' favor. It also should be of concern that gold prices have increased by 30 percent since the start of the year as investors flee the dollar.

Public finances are one area of policy relating to inflation where the United States has been very much worse than Turkey. Last year, Turkey registered a budget deficit of less than five percent of GDP while its public debt to GDP ratio was only around 35 percent. By contrast, last year the US budget deficit was around 6.5 percent of GDP and the public debt to GDP ratio stood at 100 percent. More troubling yet was the fact that while Turkey was taking measures to reduce its budget deficit, the Trump administration has been pushing for tax cuts. According to the Congressional Budget Office, those tax cuts will add $3 trillion to the budget deficit over the coming decade and take the public debt level in relation to the size of the economy to well above its end of the Second World War level.

Yet another area where the US is coming to resemble Turkey is the erratic way in which economic policy is being conducted and the undermining of the rule of law. This has been most evident in the chaotic way in which Trump has implemented his import tariff policy. This hardly creates the type of environment conducive to a pickup in investment.

The US administration would do well to study how economic policies of this sort led to the Turkish economic crisis. Maybe then, there might be hope that the administration will reverse the disastrous economic policy course on which it now finds itself.

Learn more: Three Cheers for Jerome Powell | The Stock Market's Irrational Exuberance | The Gold Price Boom Has Legs | Is Germany Without Its Debt Brake on the Right Track?

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