As developments in inflation and aggregate demand evolved in parallel with the Turkish Central Bank’s expectations, monetary policy as conducted so far was eased. The Monetary Policy Committee (PPK), after keeping policy rates constant for an extended period, initiated measured rate cuts in September. The PPK lowered the policy rates by a total of 75 basis points at its September and October meetings. The rate cuts, which started slightly earlier than market expectations, were well perceived by economic agents, lowering inflation expectations and inflation uncertainty, consequently leading to a reduction in medium and long-term interest rates.
However, despite the favorable developments in core inflation indicators, short-term forecast figures for the CPI were raised due to factors such as tax adjustments and hikes in energy, food and administered prices. Accordingly, the central bank forecast inflation to be between 6.7 and 7.9 percent (midpoint 7.3) at the end of 2007.
As seen on Graph 1, the CPI will be realized above the uncertainty range, prompting an official letter to be written to the Treasury Ministry and the IMF to explain the underlining causes as well as the required measures to be taken in order to keep medium-term inflation targets under control.
In the possible event of a CPI failure, the role of dramatically rising food prices should be noted. The rise in food prices (due to adverse weather conditions and global developments) has been the main factor slowing down the disinflation process. As of the end of the third quarter, the contribution of the food component to the overall CPI exceeded 3 percentage points (See, Graph 2).
Our personal evaluation of this failure is that the central bank has been quite successful in explaining the underlining factors for the success as well as the failure of the CPI. The central bank has continuously noted that the disinflation process requires a strong team-oriented game, collective and cooperative efforts to succeed. The central bank has enforced a satisfactory tight monetary policy and reasonable liquidity management since mid-2006, when inflation targets were missed significantly.
Unlike the Central Bank of Turkey, the government’s fiscal measures have not reflected the program it set out due to double elections in 2007. The primary surplus was declared to be 6.5 percent of gross domestic product (GDP) by the end of 2007. However, it was predicted and declared by Treasury Minister Mehmet Şimşek that the primary surplus target will be realized around 4.3 percent by the end of the year. There are, however, other factors pushing inflation up which are beyond the government’s control. These are the rise in energy prices and commodity prices -- in particular, oil prices. Moreover, official wage arrangements and tax hikes are among the factors pushing the CPI upwards.
The central bank’s estimates show that medium and long-term inflation targets are still under control. However, in order for these targets to be reached by next year, the government should decisively continue reform efforts without being caught in reform fatigue.
