Governor Başçı Should Have Listened to Assoc. Prof. Başçı

*Source: Ekonomiservisi.com ©

Governor Başçı Should Have
Listened to Assoc. Prof. Başçı

Dr. Erdem Başçı, a prominent economist, who has been serving as the Deputy Governor of the Central Bank of Republic of Turkey (CBRT) since 2003, was appointed governor on April 19th, 2011. After a controversial period in office, his term came to end in April this year. This study aims at delivering a performance evaluation of Governor Başçı during his 5 year term in the office. For this purpose, a chronological order is being employed to recall the remarkable events of his time, leaving a rather strict technical monetary policy debate to another occasion.

Monetary policy became an increasingly popular subject in the aftermath of the Global Recession, not only in the world but also in Turkey. During the recent five years, CBRT has been under spotlight. But unfortunately, the rising interest in the subject was far from delivering objective critique. Opaque monetary policy applications, poor communication by the CBRT and involving politics into the subject muddied the water further. This paper seeks to provide an objective performance evaluation of Governor Başçı, not only by presenting the figures but also with flashbacks and anecdotes of the time.

Although successor of Dr. Başçı is already being announced, an evaluation about the new Governor is clearly out of the scope and interest of this paper.

Re-thinking the Central Banking

In the aftermath of the Global Recession, the beginning of Başçı’s term in 2011 corresponds to the debates of ‘rethinking central banking’. Debates of the time were suggesting central banks to ‘go beyond their traditional emphasis on low inflation to adopt an explicit goal of financial stability’ and ‘use macro prudential tools alongside monetary policy’. Those were the days when central banks dropped down the rigid definition of inflation targeting, moved closer to flexible inflation targeting just to juggle multi-mandates; explicit or implicit.

The CBRT was no exception either. Hence the early period of Başçı in the office was very encouraging for those of us who were happy to see such a successful academic overtaking this post and actively following the global debate.

Not surprisingly, a new chapter was being opened in Turkish monetary policy with his lead. Indeed, Başçı himself summarized the change in the monetary policy boiling it down to different phases as shown in Table 1.

Table 1 Phases in Monetary Policy

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Initial steps of the CBRT included but were not limited to:

-Pushing financial stability as a co-mandate

-Spelling a cap over the loan growth rate

-Employing macro prudential measures

-Going for maturity differentiation in the reserve requirement ratios, helping to extend the maturities of deposits

-Using interest rate corridor effectively

New ‘multi-objective, multi-tool’ policy framework was a good idea at a glance, but its success was very much dependent on its application. In a presentation dating 2011, the CBRT noted that ‘The monetary stance in this framework is not only determined by the path of policy rates, but as a combination of all the policy instruments’ (CBRT Presentation, February 2011). But the transmission mechanism of the policy instruments were not clearly defined nor studied, pointing at a ‘learning by doing’ policy model and casting shadow over the application.

Table 2 Changing Policy Frameworks

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As Discretionary As It Gets

Despite this shadow, those of us who were happy to see Governor Başçı in the office chose to see the half full part of the glass. Yet soon, it became more and more difficult to be optimistic.

In his fourth month in the office, appearing on a TV interview, Governor Başçı gave a ‘fair value’ for the Turkish Lira against the equally weighted basket of Euro and US Dollar, while warning the market participants ‘not to underestimate a central bank’s power to shape the level of the exchange rate’. The level he mentioned on TV was pointing at a desired appreciation of the local currency and an implicit commitment behind by the CBRT, as it was directly pronounced by governor himself.  I am sure Assoc. Prof. Başçı would have known that, as a governor of an economy with a savings deficit and limited reserves, he should not have used such a sentence. But somehow, Governor Başçı did not mind falling into this mistake. This was the moment when those of us who were happy to see him in the office met the ‘Başçı Conundrum’: the hypothetical gap that defines the divergence of actions between Govenor Başçı and Associate Professor Başçı. And as I will show through this study, the gap widened through his term.

His implicit commitment for a stronger TL soon started an arm wrestling between the market and the CBRT. Not surprisingly, the arm wrestling ended up with the CBRT having to hike the upper band of the interest rate corridor by 350 bps. If asked, Associate Professor Başçı would have told Governor Başçı that, monetary policy associated with non-credible central banks, is not what the Bank says, but what the economic agents understand out of it and there is a cost to pay for the words that you cannot back. Harsh but fair.

Following the rate hike, ‘high-frequency monetary policy’ took off. The CBRT became highly active in fine tuning the market liquidity during so called ‘extra-ordinary’ days, by creating additional and temporary tightening in the market.

Governor Başçı described the situation in a meeting with the economists in Ankara as ‘we are buying currency stability at the expense of interest rate volatility’, without noting his personal contribution to the currency volatility.

Graph 1 Funding Cost (Per cent) vs TL Against the Equally Weighted Currency Basket (50 Per cent Euro+50 Per cent USD)

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Source: CBRT (Circles and associated explanations are added by the author)

The interchange between the interest rates and the level of currency continued, just as Governor Başçı continued to give exchange rate projections, which also continued to fail.Source: CBRT (Circles and associated explanations are added by the author)

In 2013 Governor Başçı came up with a more explicit year end call for TL against the USD, which was broadly out of the blue and failed again (ie: his projection of USD/TL 1.92 vs realized 2.14). Meanwhile the CBRT opened a new chapter of ‘buying interest rate stability at the expense of currency instability’. Considering the import dependence of the manufacturing sector in Turkey, a pass through from currency to the prices and distorting effect of depreciation on the inflation expectations, this didn’t sound like a good idea, and indeed it was not. The bill came soon after in the shape of an inevitable rate hike; ie: 425 bps in the upper band, 450 bps in the lower band, 550 in the one-week repo rate.

Another interesting nature of this ‘saving the TL’ operation was the timing of the Monetary Policy Meeting which took place at mid-night outside the pre-announced calendar. Once again in the ‘lean vs clean’ debate, the CBRT was standing to ‘clean after itself’.

Graph 2 Policy Interest Rates in Turkey, %

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Source: CBRT

The CBRT’s struggle with the currency was a clear disappointment both in 2011 and in 2013. To wrap up, one shall easily say that, at the end of this struggle, flexible monetary policy turned into discretion, controlled ambiguity turned into out-of-control ambiguity and communication turned into noise. Yet, the Bank continued to act as if “they have a plan” and turned a deaf ear to the critiques.

Meanwhile, the so called Reserve Option Mechanism, although polished greatly as a genius tool, was nothing more than a make-up. As the IMF Article IV report rightly criticized back in December 2013, ‘the increase in gross reserves has not been matched by a corresponding increase in net reserves’.

Rising Inflation, Melting Credibility

So much focused on the currency and kept standing behind the curve, price stability was a forgotten mantra for the CBRT. In the aforementioned report’s Risk Assessment Matrix, IMF was urging the CBRT to ‘set monetary policy consistent with the inflation target’.

During his term, Governor Başçı could not hit the inflation target even for single year. From 2011 to 2015, it is only 2012 that inflation realization exceeded the target with a margin that is less than the uncertainty band.

Yet, one should not forget to give credit here to Governor Başçı, for not returning to unrealistically low inflation target of 4 per cent. During his term, he stuck to inflation target of 5 per cent for the 2012-2016 period. But unfortunately there were no credible or convincing studies during his term about threshold inflation level for Turkey, making targeted inflation level just a symbol and creating fuzz between central bankers and politicians.

Graph 3 Inflation Realizations minus Inflation Target (Annual Consumer Inflation, percentage point)

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Source: CBRT, Author’s Own Calculation

While the failure in inflation targeting was obvious, the CBRT chose to deny the inflation risk until the last minute in each of these years, discrediting the value of its communication. Projections of the Bank were far from capturing the reality, hence policy rate was deemed to be wrongly measuring the state of the economy, making the discretionary attitude of the Bank explicit.

Table 3 Comparison of CBRT’s Inflation Projections and Realizations

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Source: CBRT, Author’s Own Calculations

Credibility gap during Governor Başçı’s term, obviously, stayed high. As of February 2016, CBRT’s own expectation survey points at a credibility gap of 300 bps, with the market participants having a year-end inflation call of 8.5 per cent. Meanwhile 12-month ahead inflation expectations of the market point at a credibility gap of 200 bps (12-month inflation target is calculated via interpolation).Source: CBRT, Author’s Own Calculations

Groupthink and Political Mobbing

It takes consistent communication and actions to close such a wide credibility gap. Yet the CBRT’s communication turned into a ‘doublespeak’ form in the recent years, saying one thing but meaning another. Meanwhile lack of accountability is also getting more obvious in the communication. Towards the end of 2015, the CBRT announced that ‘policy normalization’ shall be awaited. Yet, without any explanation this phrase is being removed from the CBRT’s documents. No explanation, no further guidance. Yet another mystery to be solved.

The market is far from questioning this stance, as previous attempts did not help to get any answer from the Bank’s side. One will be able to claim that the positive winds of ‘rethinking the central banking’ unfortunately did not deliver the desired results in Turkey. One of the main reasons behind is the one-man nature of this debate. The CBRT has been under the influence of ‘groupthink’, with the Monetary Policy Committee could not deliver a candidate to challenge Governor Başçı throughout these five years.

One might raise an objection here and give evidences of the political pressure over Governor Başçı. There is no doubt that, political pressure sometimes reaching to the level of mobbing has been evident in his term. Yet, it shall be evaluated in the context of Turkey’s weakening democratic culture in the recent ten years, which makes the CBRT takes its share from the pressure like many other agents in the society.

Concluding Remark

I believe both Associate Professor Başçı and Former-Governor Başçı will continue to be the most important and valuable figures of our monetary policy debate. Perhaps the note should end with a personal memory: a few years back, the CBRT organized a meeting with economists in London. Following the meeting, trying to leave the Hotel that hosted the conference, a colleague of mine and I got lost. We were lucky to come across Governor Başçı, who was kind enough to help us out. Walking in the corridor of the old Victorian style Hotel, Governor Başçı calmed us down with his friendly attitude saying that ‘easy to get lost, when it is poorly marked’. I guess, that is in fact all I want to say, about his term in the office, and Governor’s own sentence perfectly summarizes what I would like to say about his performance.

Burcu Ünüvar, Instructor, Economics Department, Bilkent University

Please cite this publication as follows:

Ünüvar, B. (April, 2016), “Governor Başçı Should Have Listened to Assoc. Prof. Başçı”, Vol. V, Issue 4, pp.28-37, Centre for Policy and Research on Turkey (ResearchTurkey), London, Research Turkey. (http://researchturkey.org/?p=11361)

Acknowledgements

The title refers to an original article by Paul Krugman, dated 24 April 2012, with the title ‘Earth to Ben Bernanke: Chairman Bernanke Should Listen to Professor Bernanke’.

Bibliography

Rethinking Central Banking, Brooking Institute (2011) ‘The Committee on International Economic Policy and Reform’,

available online at:

http://www.brookings.edu/~/media/Research/Files/Reports/2011/9/ciepr-central-banking/Rethinking-Central-Banking.PDF

International Monetary Fund (2013) ‘Turkey 2013 Article IV Consultation’, available online at:

https://www.imf.org/external/pubs/ft/scr/2013/cr13363.pdf

Yeldan, E. , Kolsuz, G. & Unuvar, B. (2013) ‘What to Smooth: Rate of interest or the foreign exchange?Turkish monetary policy under turbulent times’ , Review of Middle East Economics and Finance 10, no. 3, pp. 247-261

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