“Eventually, inflation in the Eurozone will move towards 2 percent again”

Published on: 22 July 2022

The war in Ukraine has made inflation a global issue in 2022. Including in the Eurozone, with Estonia taking the crown with inflation of more than 20 percent in June. But apart from African countries, there is no country where money has lost value as rapidly as in Turkey. Why is this, what does it mean for the Turkish population and how big is the chance that inflation in the Netherlands and Europe will get out of hand just as badly? We asked Charles Kalshoven, Senior Strategist at APG.


In June 2022, inflation in Turkey reached a staggering 78.6 percent, a figure that has not been this high for more than two decades. By comparison, in the same month, European inflation stood at 8.6 percent. The main reason for the extremely high figure in Turkey lies in the way the country is economically managed, says Kalshoven. This is because Turkey's president, Recep Tayyip Erdogan, holds unconventional macroeconomic theories.


“Turkish inflation has been able to get so out of hand because Erdogan somehow hates interest rates. It is hard to know why, but in fact he reasons as follows: when interest rates are high, companies have to incur a lot of costs - financing is expensive - and because these have to be passed on to their products, prices rise. So, he argues, if you want to keep inflation low, you have to keep interest rates low.”


Not good for their careers
In doing so, he goes directly against the consensus among economists and central bankers, which is that you need to raise interest rates precisely to keep inflation down. 

“And the central bankers in Turkey know that too, but raising interest rates has not proven to be good for their careers. Erdogan has already kicked out a number of bank presidents in the past for that reason.”

With the Turkish people’s money depreciating so rapidly, many are taking their money and investing it in assets that are more stable in value, Kalshoven says.


Gold and jewelry
“Many goods are currently being purchased in the hope that they will retain their value, such as gold and jewelry, as well as, for example, used cars. The economy may get a boost from this for a while - but it will be relatively short-lived. If everyone is primarily concerned with protecting their assets from inflation, it will ultimately not be that productive. Besides, it can also cause a negative, self-reinforcing effect. Turks are buying more foreign currency, which has caused the Turkish Lira to go down. Last year, the Lira was still worth a dime in euro cents. Now it is fast approaching a penny. This also makes imports more expensive for Turkey, which in turn creates imported inflation.”


The sharp rise in energy and food prices also plays a role in Turkey's inflation rate, but a relatively limited one. Kalshoven: “We also have these higher prices for energy and food in Europe, but here we still have single-digit inflation figures, while the Turkish economy has been showing double-digit inflation for some time now.”


Traumatic experiences
Before inflation in the Netherlands and Europe rises as high as in Turkey, a lot has to happen. After all, the interest rate policy of the European Central Bank (ECB) is diametrically opposed to Turkey’s policy and cannot just be swept off the table.


“The ECB does not have inflation on a string either, but there are solid agreements between the member states on the mandate,” he says. Christine Lagarde (the president of the ECB, ed.) can’t just be fired, that’s institutionally better guaranteed than in Turkey. Theoretically, you could exert influence through the appointment of an ECB president who pursues a distinctly specific interest rate policy. But in practice, countries like Italy, Germany and the Netherlands would have to agree on such an appointment. The Germans have had traumatic experiences with hyperinflation. So, the chances of them allowing it are very low.”


Far-reaching effects
The fact that the central bank in Turkey has still not raised its interest rates has - in addition to high inflation - even more far-reaching consequences economically. Confidence in the Turkish economy is declining, in more ways than one.

“In an attempt to keep prices in check, the Turkish government is resorting to short-term solutions. For example, it has reduced the VAT on food from 8 percent to 1 percent. It helps for a while but in the end, it is nothing more than a stopgap measure. It is not good for government finances and, as a result, financial markets' confidence in Turkish government bonds is falling. And the banking sector also benefits if the government's housekeeping is in order, because then it has easier access to foreign capital.”


No band-air solutions
Turkish consumer confidence has taken a hit and investment prospects are poor, says Kalshoven.


“Partly because the confidence level, which has fallen due to the counterproductive interest rate policy, encourages capital flight. Normally, a central bank would raise interest rates to combat that capital flight, but instead Erdogan blames the foreign interest lobby.


According to Kalshoven, the Turkish economy does not need band-aid solutions, but structural reform.


“The labor force in Turkey is growing, you want to keep those people employed. To achieve that, the country needs more exporting industry. The economy now relies too much on the construction sector and on tourism. And the latter sector is being hit hard, now that a significant proportion of tourists - Russians and Ukrainians - are staying away as a result of the war.”


The seventies

The (constitutional) situation is therefore fundamentally different in Europe and the Netherlands, and makes an interest rate policy like Turkey’s impossible. However, this does not mean that double-digit inflation is impossible in the Netherlands and Europe, says Kalshoven.


“In the 1070s, we saw that it can be done, but even then it wasn’t about percentages like Turkey’s now. And while interest rates in Europe may also be too low for current inflation, the ratio is not as skewed as in Turkey. Look, even with us there are conceivable circumstances in which inflation gets out of hand. Suppose we have a recession in which unemployment rises but inflation declines only slightly because there are mechanisms by which wages are automatically adjusted to prices - as was the case in the 1970s. The price you pay for fighting inflation - even higher unemployment - then gets really high. The call for less social damage will then certainly increase, although that is no guarantee that central banks will then cave in.” 


In any case, this scenario is not on the agenda at the moment, says Kalshoven, because the labor market is currently tight.


Not following Turkey
“And if interest rates are raised and there is a recession, that tightness will probably disappear again. The fact that we are not going to follow Turkey’s lead can also be seen from the ECB inflation forecast. In June, inflation was 8.6 percent, for the whole of this year the ECB expects 6.8 percent, for 2023 3.5 percent and 2.1 percent in 2024. Barring any surprises, such as escalation in Ukraine or new Covid lockdowns, we think that inflation in the Eurozone will eventually return to the 2 percent target. Incidentally, such a rate has not occurred in Turkey in the past 50 years.”