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December 16, 2012, Sunday

Fed’s new ‘old game’ and Turkey’s position

The Federal Reserve's at near zero even after unemployment falls close to a normal level of 6.5 percent means that monetary easing would continue at least until the end of 2015 as unemployment targets would be achieved within a span of three years and also inflation remains below its target of roughly 2 percent annually.

 It has been argued that with this decision the Fed has for the first time made clear to investors and consumers that it will link its actions to specific economic markers.

On the monetary front, the Fed said it will also keep spending $85 billion a month on bond purchases to drive down long-term borrowing costs and stimulate economic growth. Upon this decision, the Fed's investment portfolio, which is nearly $3 trillion, will swell to nearly $4 trillion by the end of 2013. It is expected that this decision will highlight the Fed's economic outlook and that such transparent guidance will make it easier for companies, investors and consumers to make financial decisions. It predicts the economy will grow by no more than 3 percent next year before picking up to as much as a 3.5 percent growth in 2014 and as much as 3.7 percent in 2015. In fact, lower rates would induce investors to shift money out of low-yielding bonds and into stocks, which could lift stock prices. Stock gains boost wealth and typically lead individuals and businesses to spend and invest more.

Can such a policy framework guarantee the expected targets mentioned above? To remind you, this framework is no longer new. It is, at best, “old wine in a new bottle.” For instance, before dropping to 6.5 percent in early 1994, the unemployment rate had peaked at 7.8 percent. Against the “jobless recovery” of the 1990s, the Fed had begun cutting short-term interest rates in mid-1990 from the now-unthinkable level of 8.25 percent to 3 percent by September 1992. Their reversal started after February 1994 in order to respond to gathering inflationary pressures. However, the Fed was fortunate at that time due to cheap energy, globalizing markets, the technological revolution and easy credit. Almost the same policies were pursued after the “soft-recessionary” pressures of the early 2000s that triggered today's mortgage sector disaster. Success is not guaranteed because, as Dr. Ben Bernanke, president of the Fed, has warned, none of the Fed's actions could outweigh the economic pain that would be caused by “fiscal cliff”-sharp tax increases and government spending cuts that are set to kick in next month as it is reducing consumer and business confidence. There are also other skeptics who note that rates on mortgages and many other loans are already at or near all-time lows. So any further declines in rates engineered by the Fed might offer little economic benefit. Also, the Fed's low interest-rate policies would hurt millions of retirees and others who depend on income from savings.

Let's focus on the possible repercussions of the Fed's new policy on the Turkish economy. Obviously, under normal conditions, as this process would result in a weaker dollar against the euro, that could help the US to improve its ever-widening current account deficit. It would make matters more complicated for the eurozone due to the loss of export competitiveness. However, this may not support Turkey's competitiveness in Europe, still its largest trading partner, because in the post-credit upgrading of Turkey by Fitch last month, excess liquidity would flow into Turkey, creating upward pressures on the lira, a process that would undermine the competitiveness of this currency. Also, rising oil prices would have a negative impact on the recovery of the Turkish economy. However, the use of credits would be much easier provided that interest rates decrease even further as long as the current account deficit and inflationary pressures are kept under control.

At this point, I would like to suggest that Turkey should boost domestic demand carefully parallel to the export performance and ease the use of credit channels parallel to the improvements in Turkey's currently poor national saving performances. In the long run, however, the homework is obviously to carry out second generation reforms and therefore improve Turkey's potential growth level above 7 percent.