Countries around the world are raising interest rates, citing concerns about higher inflation. Central banks in Latin America and the Caribbean, Central and Eastern Europe, East and South Asia, Central Asia, the Middle East and sub-Saharan Africa raised their interest rates last year. Higher interest rates make it more expensive for households and businesses to borrow money — and economists expect this will help keep inflation in check.
But Turkey — where inflation last month hit 36 percent, among the world’s highest rates — chose to cut interest rates on four separate occasions between September and December 2021, reducing the central bank’s key lending rate from 19 percent to 14 percent.
My research suggests that Turkey’s interest rate reductions are likely to have important political consequences. Lowering the interest rate has caused the value of Turkey’s currency, the lira, to plummet, which hurts the popularity of Turkey’s ruling party.
Why Turkey cut interest rates
One person in Turkey bears primary responsibility for these rate cuts: President Recep Tayyip Erdogan. The president dismissed a number of central bankers who stood in the way of lowering interest rates and replaced them with people who share his views on this matter.
Erdogan often calls high interest rates the “mother of all evil”. He has justified his support for low interest rates on his Muslim faith and his interpretation of the Koran’s commandment that prohibits the charging of interest. Erdogan believes that lower interest rates actually reduce inflation — a view that’s the exact opposite of what most economists and policymakers believe.
Low interest rates can be attractive for political reasons. Firms and households that want to borrow money like it when they can do so more cheaply. One report posits that the roots of Erdogan’s “antipathy [toward high interest rates] may lie in part in the pain they heap on to heavily indebted small companies”, a group that is “the bedrock” of his political support.
Low interest rates have other costs
But low interest rates also come with other costs — for emerging economies, these costs can become acute when U.S. interest rates are on the rise, as they have been lately. When the U.S. raises interest rates, money flows out of emerging markets and into the United States in order to earn these higher rates of return. This also strengthens the value of the dollar relative to other currencies. But if other countries respond by raising interest rates themselves, they can prevent capital outflows and the weakening of their currencies.
Turkey’s decision to cut the central bank rate has the opposite effect. It gives professional investors and ordinary savers alike more reason to sell lira and buy foreign currency, which pushes down the lira’s value.
In September, before Turkey’s central bank started cutting interest rates, the exchange rate was $1 to 8.5 lira. By Dec. 21, it took 17.5 lira to buy $1. The lira regained some ground, but is currently more than 50 percent below where it was four months ago, before the rate-cutting experiment began.
Here’s how that the rapid loss in the lira’s value affected Turkey’s economy. A weaker currency makes imports more expensive, which further fueled the country’s already-elevated inflation rates. Higher import prices tend to disproportionately harm poorer citizens — who spend a larger share of their income on tradable goods.
A weaker currency is also a problem for Turkey’s business community. Banks and other corporations in Turkey have to finance their debts in dollars and euros. The weakening of the lira makes it harder for these firms to repay their debts, which poses a threat to the financial well-being of Turkish companies.
What about the political costs?
The Turkish currency crisis has sparked protests throughout the country. The sharp drop in Erdogan’s approval also suggests that the country’s monetary problems are undermining the president’s popularity. My research provides further evidence that currency crashes hurt the political standing of national leaders.
In 2018, during another period of currency depreciation, I asked a nationally representative sample of Turkish adults what they thought about the lira’s depreciation. The survey, conducted by Frekans Research, used face-to-face interviews with 2,000 people, who were randomly sampled from within randomly selected regions of Turkey. Over 90 percent of respondents thought the depreciation of the Turkish lira was bad for them personally. A similar share (89 percent) agreed that the depreciation of the lira is bad for the country.
In a recently published article drawing on this survey, I explain how the lira’s depreciation probably cut some electoral support for Erdogan’s ruling Justice and Development Party. The study compares people who were interviewed on days when the lira was strong with otherwise similar people interviewed after the lira’s July 2018 crash. I estimate that the 6.5 percent depreciation of the lira that occurred that month reduced electoral support for the incumbent party by nearly seven percentage points.
Does Erdogan’s future depend on the lira?
In late December, Erdogan redoubled his efforts to stabilize the lira. While still refusing to raise interest rates, he unveiled an unconventional — and risky — scheme to discourage Turkish savers from selling lira. The central bank simultaneously stepped up its intervention in the foreign exchange market. These measures succeeded in strengthening the Turkish lira, albeit only briefly. The lira’s depreciation resumed shortly thereafter.
Some commentators now speculate that Erdogan’s monetary policy decisions could ultimately “cost him his job”. Turkey’s next election is scheduled for June 2023 — but some analysts believe Erdogan will call for an election earlier. My research on Turkey, and evidence from other currency crises, suggests that the outcome of that election will depend on whether the lira continues to fall.
David A. Steinberg is an associate professor of international political economy at Johns Hopkins School of Advanced International Studies.