Turkish Inflation

The March 2001 edition of Newsweek carried an article entitled “Is This the End of Inflation? Turkey’s currency crisis may be the last battle in the global war against hyperinflation.” The article cited Turkey as the last major country struggling against out-of-control prices. The 1990s saw inflation rates around the world subside to the point that some observers suggested that the global economy could turn the corner from inflation to deflation. Turkey was one exception to the trend. As of 2008, Turkey had pared inflation down to single-digit territory.

Turkish inflation is more notable for its long, sustained rise in prices rather than for episodes of wild hyperinflation. Between 1964 and 2001, Turkey only saw two episodes of inflation that sent prices increasing at triple-digit rates, and even then, the inflation rates fell short of hyperinflation territory. In 1980, annual inflation soared to the 110 percent range.

In 1994, Turkey once again posted annual inflation rates around 110 percent. Nevertheless, average inflation rates steadily climbed. Between 1964 and 1980, annual inflation rates in Turkey averaged roughly 21 percent. Between 1981 and 1989, annual inflation rates in Turkey averaged roughly 41 percent. Between 1990 and 2001, annual inflation rates averaged roughly 72 percent.

The core problem appeared to be political. No one party could ever win an absolute majority, and the coalitions put together to form governments encouraged short-sighted thinking. Various governments borrowed to pay for various votecatching programs, including substantial pay raises to public employees. An inefficient tax collection system and large underground economy compounded the problems. Subsidies to sluggish stateowned enterprises and interest on the public debt added to the deficit. Before the spike in inflation in 1994, Turkey had seen public sector borrowing as a percent of gross domestic product (GDP) rise from 3.7 percent in 1986 to 12.3 percent in 1993. Shortterm borrowing from the central bank accounted for 15 percent of the government’s budget. When central banks purchase government bonds, they add to the money stock in circulation. The central bank also had a history of caving in to demands of ailing commercial banks for more funds.

In 2001, the IMF approved a rescue package of $8 billion to help Turkey avoid hyperinflation and debt default. The $8 billion was on top of a previous $11 billion committed under a previous antiinflation program. The package came with conditions that Turkey privatize debt-ridden state enterprises, reform a corrupt banking sector, and increase government tax collections. The IMF also required Turkey to peg the Turkish lira’s value to a basket of euros and dollars. Turkey could not add to the supply of Turkish lira without increasing the central bank’s holdings of foreign reserve assets.

Turkey brought down inflation with highly stringent monetary policy. As of 2006, Turkey’s central bank was keeping its key lending rate steady at 22.5 percent and inflation was hovering around 10 percent.

Persistent inflation left its marked on the Turkish currency, the Turkish lira. Before the reform of the Turkish currency in 2005, Turkey boasted the largest denominated banknote in the world, a 20 million Turkish lira banknote. The large number of zeros in figures recorded in financial statements caused technical and operational problems, particularly for banks and the treasury. The Law on the Currency Unit of the Republic of Turkey, No: 5308 became effective on January 1, 2005. This law created a new currency equal to the old currency minus six zeros. One unit of the New Turkish lira equaled 1 million units of the old currency unit. Both the New Turkish lira and the Turkish lira circulated concurrently for one year. As of January 1, 2006, the New Turkish lira became the Turkish lira. All bank accounts were converted from Turkish lira to New Turkish lira.