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Introduction
US has been the center of the global economy for the past several decades, and hence decisions taken by the U.S government can have significant impact on the rest of the world. In the same manner, the monetary policies formed by the Federal Reserve (FED) – the central bank of the United States –influence the economic policies of other countries worldwide. Therefore, central banks worldwide are closely monitoring the moves of the FED so as to make timely adjustments to their economic and monetary policies. The U.S economy was severely hit by the global financial crisis 2008-09. In an attempt to recover from the dreadful impacts of the recent global recession, the FED kept the interest rate unchanged (low) until December 2015.Evidences suggest that a low U.S interest rate for consecutive seven years following the recession helped emerging countries to attract foreign investments and to achieve a tremendous GDP growth rate thereby. The U.S FED slightly increased its interest rate in December 2015 signaling that the country’s economy has recovered the recessionary pressures. However, an increase in the U.S interest rate affected the growth momentum of emerging economies in various ways. This paper will critically evaluate how FED’s decision to alter interest rates affects Turkey and Turkish economy as a whole.
Interpretation of FED’s Interest Decisions
It is identified that the Federal Reserve (FED) periodically adjusts its interest rates to support stable and long-term growth of its economy. The major reason for this interest rate change is to stabilize the country’s economic growth. As Pope purports in his article, “When the FED raises or lowers interest rate”, the FED always tries to maintain a healthy economy. If the FED finds that the U.S economic growth is too slow, then it may lower the interest rate to foster circulation of money in the economy so that more money would be available to businesses and buyers. It is clear that increased volume of business transactions would stimulate economic growth and assist the U.S to gain growth momentum. In contrast, if the FED observes that the country’s economy is growing too fast, it would raise interest rates to limit business transactions and thereby slow things down (Pope). To make the interest change scenario clearer, low interest rates may persuade people to borrow more, and naturally they would spend more. It is important to note that a low interest rate may weaken the dollar and the situation in turn may be harmful to the U.S economy in the long-run. However, when the value of dollar is weak, foreign goods will become costly, and therefore Americans may switch their demand to domestically-made products. This situation may stimulate short-term growth of the economy because of higher demand for domestic goods and increased employment and wages. However, it is not sensible to keep interest rates low always as this situation may lead to inflation. To explain, if demand exceeds supply in a country, then markers tend to increase product prices thus leading to inflation. It is identified that high inflation would impede the economic growth of the country because higher prices may result in decreased demand, decreased production, and eventually unemployment. Hence, the FED is required to adjust interest rates periodically to achieve a balanced and stable economic growth.
Factors Influencing FED’s Decisions
There are numerous factors affecting the FED’s decision to alter the interest rates from time to time. Primarily, the FED observes various economic indicators to take decision on interest rates. For this, the FED relies increasingly on the Beige Book, which contains a detailed summary of economic conditions prevailing in 12 Federal Reserve districts. According to Deena Zaidi, if the Beige Book reports positive economic activities across various industries in most of the U.S districts, then the FED would consider this economic data as a green light for increasing interest rates. Improved unemployment rates, stable prices, and an attractive growth rate reflect that the U.S economy requires a reduction in expansionary measures, and this economic condition influences the FED to bring a gradual increase in interest rates (Zaidi). Similarly, inflation rate will be a crucial element affecting FED’s interest rate decisions. Currently, the FED monitors various price indices so as to gain a detailed understanding of prices of various products and services, and therefore, the FED can obtain a clear picture of inflation in the country. The FED also focuses on personal consumption expenditures (PCE) to critically evaluate inflationary pressures in the economy. The FED always wants to maintain a moderate inflation rate. Hence, if the FED observes a high inflation rate in the economy, it would raise interest rates to limit people’s borrowing power. When people do not have enough money to spend on goods and services, supply would exceed demand thus forcing marketers to reduce prices. Likewise, if the FED monitors a low inflation, it would lower interest rates to increase people’s borrowing power and to stimulate economic activities in the country. This situation in turn would lead to increased demand for goods and services, and therefore, there will be a subsequent increase in consumer prices. It is also identified that growing concerns about emerging markets can have an influential role in setting FED’s interest rate decisions. Even when the U.S economy is healthy with low oil prices, continued economic growth, and lower unemployment, the Federal Reserve is concerned about the impacts that growing markets, specifically China, can have on the U.S economic growth (Zaidi).Therefore, the FED closely monitors economic activities of emerging markets such as China, and brings corresponding changes in its interest rates timely. The FED’s intervention in the economy during the global financial crisis 2008-09 was commendable. According to a report in Fed’s Response, “The Economy: Crisis and response”, the FED lowered interest rates notably, and enhanced the flow of credit to creditworthy borrowers during and post-recession to stimulate economic activities in the country. The FED took seven years to raise the interest rate slightly in 2015 following the recent global financial crisis. Throughout these seven years, the FED kept its interest rate low in order to boost and stabilize economic activities in the country (Cox Jeff).The U.S regulators believed that a low interest rate would assist the country to get rid of the recessionary pressures and to expedite its post-recession recovery process. Recent economic data indicate that FED’s decision to keep interest rates low during and the post-recession period helped the economy recover fast.
Effects of FED Decisions on Turkey and Turkish Economy
It is identified that an FED decision to increase or decrease interest rates can have significant effects on Turkey and the Turkish economy. Economists say that the Turkish currency Lira is increasingly vulnerable to a U.S rate increase. As reported by reported in Peker and Albanese, Lira fell to a record low of 0.3258 (0.8%) in September 2015 as the global currency markets expected an interest rate hike by FED in the next meeting . It seems that a FED decision to keep interest rates low is beneficial to emerging economies like Turkey. Being one of the fast emerging economies in the world, Turkey has become a potential choice for global investors. When the FED kept its interest rates low during and post-global recession periods, the Turkish economy experienced a surge in foreign investment. To make it clear, a low U.S interest rate implies that global investors have greater borrowing capabilities and they would invest significantly in emerging markets like Turkey. Undoubtedly, increased foreign investment can help improve the living standards of Turkish society for several reasons. When foreign firms, particularly U.S firms, expand into Turkey to take advantages of a favorable U.S interest rate, the situation would create more employment opportunities in Turkey. In addition to improving the Turkish unemployment rate, influx of potential foreign investors can benefit the Turkish government to increase wages for its citizens. Evidently high employment rate together with improved wages will increase the spending capacity of Turkish people, and hence they can obtain access to quality living facilities. When its citizens have enough employment opportunities and better wages, the Turkish government will be able to invest in other basic facilities such as health, education, and infrastructure development and to concentrate more on productive ventures. It is obvious that quality of the education system is a vital factor determining the future of a country. Hence, increased investment in the education sector can aid the Turkish government to develop potentially skilled, professional, and creative candidates who can better support the country’s future growth. Likewise, improved investment in the health sector is good for the Turkish government to maintain a healthy population and to increase the productivity of country’s labor force. It is also clear that development of infrastructural facilities is a primary factor influencing foreign direct investment and determining growth of the Turkish economy. In short, a low U.S interest rate can be beneficial to Turkey in the sense that this favorable situation would improve the daily lives of Turkish people. Therefore, a rise in the U.S rate may limit the inflow of foreign investment to Turkey, affecting Turkish unemployment and wages adversely.
While analyzing the effects on the Turkish economy, it seems that a U.S interest hike would limit the foreign investment flow to Turkey thus hindering the GDP growth of the country. In addition, an increased unemployment rate caused by reduced foreign investment may negatively impact the economic development of Turkey. Considering that Turkey is one of the fast emerging economies in the world, a surge in the unemployment rate and associated job cuts would prevent the country from using its full potential to grow further. This unfavorable economic situation may also limit the country’s ability to compete with other emerging Asian markets such as China and India. As noted already, the Turkish currency Lira is extremely vulnerable to a hike in U.S interest rate and this unstable nature of the Lira causes global investors to lose their confidence in the Turkish economy. Hence, it is clear that an increase in the U.S interest rate would lead to a subsequent fall in the Turkish Lira. The primary risk of having a weak currency is that Turkish consumers planning to purchase foreign-imported goods and services will be needed to pay more. Sometimes Turkish people will be required to pay more for domestically-produced commodities too if local producers import some parts or components of the product from outside countries. This situation would persuade domestic consumers to put off their purchases to a future date and the situation in turn would limit trading activities in the country. Therefore, a weak currency may slow down the economic growth of Turkey. The more serious issue is that speculation over U.S interest rate hike has been significantly contributing to currency depreciation in Turkey for the last several months. This issue hurts the Turkish economy more seriously than an actual U.S rate hike because the uncertainty created over an expected interest rate increase by FED causes economic instability in Turkey. According to a report by Dana, an interest rate raise in U.S would cut the flow of cheap money to emerging markets like Turkey and exacerbate domestic instability in the region. The author adds that growing domestic instability can have a series of adverse geopolitical consequences in the region.
It is important to note that Turkey was able to achieve good economic growth rate even when the global financial crisis 2008-09 was on its peak since the country had access to a potential pool of foreign capital (Dana).To illustrate, the Turkish economy grew 9% in 2010 and 2011. Hence, the historically low interest rates kept by the FED enhanced constant flow of cheap money to Turkey and paved for Turkey’s economic expansion (Dana). However, the situation changed notably ahead of the U.S rate hike in 2015 and the country was expected to grow by just 3% that year. Hence, a hike in the U.S interest rate would cause Turkey to lose these economic advantages and be forced to seek other potential sources of capital to support its economic growth. A rate hike by the FED would make things bad in Turkey because some capital-intensive infrastructural projects are underway in the country. These infrastructure development projects include “a third bridge spanning the Bosphorus, an underwater tunnel linking the European and Asian continents, and a new airport that will be Europe’s largest” (Dana). Hence, when the Turkish government’s accessibility to foreign capital is restricted suddenly, the government would find it extremely difficult to fund those capital-intensive infrastructure projects that are underway. The situation may lead to anti-governmental protests in the country and worsen the domestic stability of Turkey. In the current situation, Turkey does not have a potential alternative source of finance to meet its growing fund needs in an effective manner. According to Kottasova Ivana, a crucial problem hurting the Turkish economy in the event of a U.S rate hike is, it imports a lot more than its exports. Since a rate hike in the U.S would lead to depreciation of Turkish Lira, imports will become a lot more expensive for Turkey (Kottasova).This unfavorable economic situation would dreadfully affect the country’s import sector, which is recognized to be a strong pillar of the Turkish economy. The Standard & Poor’s says that the Turkey’s banking sector relies too much on foreign short-term credit lenders. Currently, the country has a foreign debt of nearly $125 billion representing nearly 8% of the country’s GDP. Hence, a rise in the U.S interest rate means that it would be costlier for the Turkish government to service its enormous short term debt. In this context, an increase in U.S interest can have an economic toll on the Turkish society.
In the context of the U.S interest rate hike, the weak political stability of the Turkey seems to worsen economic conditions in the country. In other words, the current political spectrum of the Turkey is not potential enough to handle economic difficulties created by the FED’s decision to raise interest rates. Since the Turkish Lira is increasingly exposed to FED’s monetary policies, one can say that Turkey’s future economic expansion is very much depended on the United States. In addition, the FED’s decision to increase interest rate would negatively affect the Turkish housing sector because housing market is already expensive and home prices are soaring in the country. At this juncture, a limited access to foreign capital may adversely affect Turkish people’s ability to afford their own home.
As shown in the Fig.1, Turkey is a country that increasingly depends on external financing. Hence, a hike in the U.S interest rate and associated cut in the flow of foreign capital to Turkey would adversely affect Turkey’s ability to rely on external financing to meet its fund needs. Therefore, Turkey may be unable to deal with the consequences of an interest rate hike by the FED.
Turkish reaction to FED decisions
As per Daily News report “Turkey has ‘no fear’ of a Fed rate hike: Central Bank head”, even when the Lira fell to a record low as investors anticipated a U.S rate hike, the former Turkish Central Bank Governor Erdem Basci firmly responded that the country has no fear of an anticipated U.S rate hike. The Governor added that the Turkey had taken appropriate measures to address a rate hike by the U.S FED (Daily News). Basci said that the bank would review its monetary policy framework if circumstances require. He also indicated that the Central Bank would consider increasing rations paid to Turkish banks up to the Fed level.“Basci signaled at possible moves to simplify monetary policy in a scenario in which fluctuations in the long-term rates slow down permanently after normalization process starts in global money markets”. (Daily News). However, the Turkish Central Bank admitted that depreciation of Turkish Lira against the U.S dollar had delayed improvement in inflation. Even when tensions escalate over an anticipated U.S rate hike, the Turkish Central bank forecasted a moderate economic growth for the second-half of 2015 along with an improvement in account deficit. Although the central bank was optimistic about the improvement in current account gap, it worried that “the foreign demand will limit the improvement” (Daily News). However, after Donald Trump’s victory in the U.S Presidential Election, investors around the globe are preparing for an interest rate hike by the U.S FED. This uncertain market condition again resulted in the depreciation of Turkish Lira that had been strengthening from a record low of TL3.42 against dollar. In this context, the Turkish Central Bank was forced to raise its interest rate for the first time in nearly three years. As Srivastava and Wheatley report, the Central Bank decided to increase the interest rate despite the President Recep Tayyip Erdogan’s request to cut rates. Currently, the Turkish Central expects a hike in the U.S interest rate in the near future and wants the economy to prepare for it.
Conclusion
Works Cited
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Dana, Joseph. “Impact of Fed's interest rate move will be felt beyond markets”. The National Opinion, September 27, 2015. Web.http://www.thenational.ae/opinion/impact-of-feds-interest-rate-move-will-be-felt-beyond-markets [Accessed 7 Jan. 2017].
“Fed’s response”. The Economy: Crisis and response. Web.https://sffed-education.org/econanswers/response.htm [Accessed 7 Jan. 2017].
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Daily News. “Turkey has ‘no fear’ of a Fed rate hike: Central Bank head”. Daily News, 2017. Web. http://www.hurriyetdailynews.com/turkey-has-no-fear-of-a-fed-rate-hike-central-bank-head.aspx?pageID=238&nID=86205&NewsCatID=344 [Accessed 7 Jan. 2017].
Srivastava, Mehul and Wheatley, Jonathan. “Turkey lifts interest rates as pressure builds on emerging markets”. Financial Times, 2016. Web. https://www.ft.com/content/78f5f09e-b249-11e6-a37c-f4a01f1b0fa1 Accessed 7 Jan. 2017].
Pope, Ethan. “When the FED raises or lowers interest rate”. Foundation for living, 2000. Web. http://www.foundationsforliving.org/articles/foundation/fedraiselower.html [Accessed 7 Jan. 2017].
Peker, Emre and Albanese, Chiara. “Turkish Lira Falls to Record Low as Fed Decision Looms: The currency is one of the most vulnerable assets to a U.S. rate increase”. The Washington Street Journal, (Updated Sept. 14, 2015). Web. http://www.wsj.com/articles/turkish-lira-falls-to-record-low-as-fed-decision-looms-1442228239 [Accessed 7 Jan. 2017].
Zaidi, Deena. “3 Factors Fed Is Watching for Rate Hike”. The Street, Sep 9, 2015. Web. https://www.thestreet.com/story/13276160/1/3-main-factors-federal-reserve-is-watching-for-september-interest-rate-hike.html [Accessed 7 Jan. 2017].
