Delusion and Despotism: Why Erdogan’s Monetary Policy is to Blame for Turkey’s Financial Crisis

Turkish President Recep Tayyip Erdogan addressing supporters in Izmir. Erdogan’s policies have been criticized by many for inadequately addressing the nation’s rising inflation. Photo courtesy of Oğulcan Bakiler.

2022 has not been a good year for the Turkish economy. A year ago, Turkey’s inflation rate was 19%, but by April of this year, the inflation rate hit a twenty-year high of 70%. Today, inflation is officially reported at 80%, although some independent economists estimate a rate closer to 150%. The dual burdens of rising prices and a rapidly depreciating currency have devastated a country that was only barely starting to enjoy the luxuries of middle-income nationhood. 28% of the Turkish population now lives in poverty. Using the high estimate of 150% inflation, Turkey’s “despair index”–which unites inflation, unemployment, and poverty–is worse than Russia and Ukraine. Independent economists suggest that Turkey could slide into a “devaluation-hyperinflation scenario” akin to Argentina or Venezuela, the result of which could be similar to how in October 2021, it took 4,191,337 Venezuelan Bolivares to buy a U.S. dollar.

This crisis didn’t come out of nowhere. After enjoying nearly two decades of relatively stable economic growth, Turkey’s past few years have seen its economy come apart at the seams. In order to fuel economic expansion, Turkey accepted high levels of foreign currency-denominated debt. However, low currency reserves relative to that debt made Turkey’s economy vulnerable to exchange-rate shocks that could have an exaggerated effect on the value of its currency, the lira. Simply put, Turkey didn’t have the financial resources to quickly and effectively contain small economic disruptions before they became bigger ones.

In 2018, an exchange-rate crisis was finally ignited when those high debt loads were paired with financial sanctions and higher tariffs on steel and aluminum imports from the United States, instigated after a dispute over Turkey’s adoption of a Russian missile defense system. The value of the lira quickly plunged in international markets, resulting in a downgrade of Turkey’s sovereign debt ratings––making it more difficult for the country to attract investors. The Turkish economy contracted in 2019, but by early 2020 it was growing again. While the pandemic halted this recovery, by 2021, with the easing of quarantine restrictions and extensive government stimulus the country saw double-digit growth (11%) for the first time since 2011. Turkey’s President, Recep Tayyip Erdogan, publicly announced that he expected inflation to level off.

But that didn’t happen. Alongside the weakening of its currency, the high levels of government spending and a relaxed monetary policy––used to increase consumer demand and rebalance the economy––contributed to a consistent increase in the inflation rate throughout 2021. Traditional economic theory suggests that when inflation is increasing too fast, governments should conduct contractionary economic policy––raising interest rates and reducing spending––in order to cool down the economy and prevent a dangerous spiral of price increases. This is what the U.S. and nearly four dozen other countries have done to fight the current wave of inflation hitting global markets. But Turkey pursued a different strategy.

Erdogan, who has been widely criticized for expanding executive authority and jailing opposition leaders and journalists, has publicly proclaimed that interest is “the mother and father of all evil.” Drawing on the Islamist sentiment that has earned him a strong base of support in working class communities and rural regions, he has linked the high interest rates necessary to combat inflation with the usury forbidden in Islamic scripture. After spending tens of billions of lira to resuscitate a flailing economy to no avail, Erdogan has claimed that high interest rates are a cause of inflation, and blamed Western interference as the cause of Turkey’s economic issues. In his speeches, he has relied on economic conspiracy theories. Erdogan argues that Turkey is fighting an “economic war of independence” against the “interest rate lobby.” He has promised the public that he “will never compromise on this issue.” The president’s decision to embrace and promote conspiracy theories has not only facilitated nationalist political discourse, but has caused the government to ignore crucial policy advice from experts who warn that Turkey’s economic outlook is rapidly deteriorating.

In mid-2021, as inflation began to crawl upwards and the lira continued to plunge in value, Erdogan made good on these promises. He fired Naci Agbal, the third head of the Turkish central bank in two years. To fight inflation, Agbal had increased interest rates and tightened the bank’s monetary policy. Erdogan replaced Agbal with Sahap Kavcioglu, a member of Erdogan’s party, the AKP, and a former lawmaker who many see as a loyalist sharing Erdogan’s economic ideology. Many criticized this move as compromising the central bank’s autonomy from politics and executive power. Subsequently, interest rates were cut by 5% the same year, causing the lira to plunge to a record low value and paving the way for the current crisis.

There doesn’t seem to be much political logic to Erdogan’s economic choices. His stance on monetary policy reflects a larger turn towards nationalism and anti-Western populism that has intensified as he has consolidated power and survived an attempted military coup. This new despotic nationalism has seeped its way into Turkish foreign policy, inviting a more aggressive and adventurous international presence––a diplomatic posture that has itself become a partial cause of Turkey’s financial issues. The same beliefs have led him to unconditionally reject assistance from international organizations like the IMF, which can be critical to helping emerging economies stabilize their economies. But in the wake of skyrocketing food and energy prices, the country’s economy has become the biggest political issue and the AKP has seen its approval ratings drop to historic lows. The CHP––Turkey’s main opposition party––and its allies are optimistic that upcoming elections in 2023 may finally mark the end of Erdogan’s 19-year hold on power. These opposition parties have agreed to a variety of ambitious political reforms, including reducing the power of the president, restoring the independence of government agencies and the judiciary, and regulating the informal economy, which accounts for a quarter of Turkey’s GDP. These policies could help stabilize Turkey’s economy in the short term and allow for sustainable growth in the long term.

While Turkey is by no means a functioning democracy, the ruling AKP still seeks and requires democratic legitimacy from the people and victory over the opposition. If Erdogan loses the presidential election and the opposition wins a majority in parliament, Turkey may be able to course-correct and revive its economy. However, if Erdogan manages to weather the crisis and maintain political control, new term limits would allow him to keep running for office until 2034. This would be a disaster for Turkey. Erdogan’s insistence on making decisions based on conspiracy theories and taking economic nationalism to unwieldy extremes has eroded public confidence in his ability to run an economy. Without a swift transition of leadership, there is little hope that Turkey’s economy can avoid self-destruction