The inflation inertia issue

Demand and cost-side factors can be brought under control with various monetary and fiscal policies.

Lack of interest support. Demand and cost-side factors can be brought under control with various monetary and fiscal policies. In the case of demand inflation, there is an inverse relationship between interest and inflation. If the interest rate decreases, inflation increases, that is, if inflation increases, it is necessary to increase the interest rate in order to reduce it. Inflation will decrease as high interest rates will lower the exchange rate and demand. Due to the unstable costs that occur in the current environment where difficult processes such as epidemics and wars are experienced, it is difficult to manage inflation expectations, even if there is a possibility of inaction or reverse action, even close to zero.

So why don't policy makers want high interest rates? The main target until the 2023 elections is to increase investments, reduce unemployment and relieve the lower income group. A slowing growth with declining investment and rising unemployment is not desirable at the moment, as higher interest rates will dampen these trends. Since there is high inflation on the other side of the scale, this policy needs to balance, otherwise the damage of high inflation to the lower income group will be much greater. Decision makers in the economy want to control the effects that cause high inflation with additional measures aimed at providing liraization, especially the exchange rate. Apart from this, price controls are tightened, considering that some of the high price increases that are reflected to the consumer exceed the economic fundamentals and global cost increases.

Inflation reflection problems and uncertainty – prices rise, rise, and rise –… Typically, the factors that create inflation in an economy are multiple, resulting in a multi-channel nature of inflation. Since only one of these channels does not feed the inflation itself, the fight against inflation requires a special focus in policy implementation. Demand (inability of the supply of goods and services to keep pace with the increase in aggregate demand), cost (continuous increase in the cost of goods and services produced), money supply (if the money supply increases, the price of money decreases, demand increases and inflation increases), and inflation expectations (if the expectations are that inflation will increase, demand and prices are constantly increasing) are the main of these factors.

The self-creating nature of inflation is a very important problem that paves the way for hyperinflation. Such a situation causes dollarization (currency substitution) in a country to replace the local currency with all the functions of the foreign currency. In other words, people demand more foreign currency, commercial life shifts to a foreign currency basis (such as making commercial transactions, purchases, contracts in dollars).

Comparison of CPI, commercial and individual loan rates… Source: CBRT, TURKSTAT, Tera Yatırım

 Who pays the price? TL? TL deposit holders? The answer to this question depends on how we read the variables. Namely;

If deposit rates rise, savers will be more willing to deposit their money and the volume of deposits will increase. On the other hand, low loan interest rates will make it attractive for consumers to use loans and consumption will increase. So, are these factors determined only by the policy rate of the Central Bank? Under normal circumstances, the policy rate should determine, but as in the current situation, if there is a difference between the policy rates and the money and risk costs that make up the interest in the market, of course, the interest rates may be different (mostly higher) than the policy rate.

Even though the policy rate is currently being reduced, the level of deposit rates in the market is different. On the other hand, the levels of loan interests in commercial and individual categories are quite different from each other. Since the foreign exchange has been stabilized with different external financing elements, the currency protected deposit instrument is no longer attractive. Since the purpose of the saver who comes to this instrument is not to get interest, but to guarantee the increase in foreign exchange, it is normal to decrease the stock here. So why are the normal TL deposit rates increasing? The answer is that policy makers who want to accelerate the TL conversion have increased the RR commission penalty for banks. Banks that cannot increase their TL deposits above 50% have to park this 8% penalty at the Central Bank. That's why deposit rates are high, especially for newly opened accounts.

In loan interest rates, retail loans are at the level of 30.75% on average as of the CBRT's data for the week of December 2nd. The interest rate of commercial loans is at the level of 15,89% according to the same data. The difference stems from the politics-within-politics equation. Namely; It is desired that personal loans do not run into foreign currency, so the cost is high. Many sub-conditions have been created, as commercial loans are not intended to be in foreign currency. The general aim is to ensure that commercial loans go to areas that contribute to growth, that is, in the form of investment loans. However, the 10 million TL and 5% conditions, especially for the foreign currency position in the balance sheet, cause many companies to be subject to restrictions. Banks are also taking out loans more slowly as they have difficulty in calculating the risk cost due to the obligations imposed on them.

 Conclusion? One fact that everyone agrees on is that inflation is also on the rise around the world. Food and energy prices are at record levels. This increase is largely due to the increase in post-pandemic consumers, disruptions in the global supply chain, and Russia's invasion of Ukraine.

The concept of inertia that emerges in us is mainly based on internal factors, but… Namely; If the interest rate is low, the value of money decreases. In this case, you have to spend more units of money to be able to demand goods and services. In other words, if the current money in your pocket does not increase as much as inflation, you can now buy less goods and services. If we think that this is in a constantly repeating cycle, inflation and the decrease in purchasing power against it will be taken for granted, and it will be more profitable to spend today than to spend tomorrow. This creates demand asymmetry and allows demand to continue even though prices are constantly rising. Since borrowing will be considered advantageous in applying interest rates below inflation, the range of expenditures extends beyond savings.

The concept of inertia, which is defined as "the state of inaction and laziness", when used for inflation, expresses the situation where prices do not show a downward trend due to the adjustments of all actors in the economy based on inflation expectations. In simpler terms, inflation does not go down to the level it should be because the public believes that inflation will not decrease. Confidence in the steps taken to reduce price increases and verbal guidance play a critical role in breaking the inflationary inertia. In order for the steps taken to be effective, behavioral transformation throughout society is also important, while strengthening communication channels plays a critical role in addition to structural policies.

Initially, only the exchange rate and inflation expectations, which are based on the inflation of the previous period, take into account the course of past price increases in advanced models. This actually creates an inertial effect in countries with a history of high inflation. The way for the society to create a new expectation and break the inertia by isolating itself from these figures in its historical past is only possible by establishing an element of trust in the steps to be taken by policy makers and believing in the fight against inflation.

Kaynak: Tera Yatırım-Enver Erkan
Hibya Haber Ajansı