Developed countries are in a low growth period, which is likely to last another 5 years or, even, a decade.

Like other developing countries, Turkey also faces new economic challenges under the new normal. Let’s try to understand how the Turkish economy stood firm against the GFC and then to analyze why the current conditions are different from the past. There are different reasons that could explain Turkey’s strength against the GFC. Firstly, the Turkish financial system has been well-regulated and supervised since the 2000/2001 crisis. Secondly, strong public finance (low public deficit and debt) prevented any need for Turkey to take austerity measures. Thirdly, the Turkish financial system is not so deep and complex. It didn’t actively engage in risky or complex financial instruments. Lastly, Turkey’s diversification of export markets compensated for a loss of exports to EU countries during the GFC.

The problem with the current situation of low global economic growth is not directly related to financial markets. It is more about the real economy. For this reason, Turkey’s relatively strong financial system cannot be counted as a big advantage for Turkey at this time. The adaptation of a multidimensional foreign policy had increased Turkey’s economic cooperation with its neighbor countries (Russia, Syria, Iraq and Iran). This development has not only expanded Turkey’s export volume, but has also reduced dependence on exports to EU countries. After the slowdown of the European economy, Turkish exporters compensated by focusing more on MENA countries and Russia. Russian and Middle Eastern markets stood in the breach. This strategy worked well until 2014. But, strained relations with Russia after the downing of the Russian jet, and the deteriorating situation in Syria and Iraq have caused severe damage to Turkish exporters. Therefore, Turkey’s diversified export channels cannot provide adequate support for its economy this time.

Now, Turkey should confront the challenges of the “new normal” in an aggressive way.

All these developments indicate that Turkey should now confront the challenges of the “new normal” in an aggressive way. Policy options are different for the short-run and the long-run. Short-run policies (fiscal and monetary policies) are not so special and unknown receipts, but this doesn’t mean that they are inessential. Fiscal and monetary tools are necessary for short-run stabilization. Since public finance has room to maneuver, expansionary fiscal policies (e.g. increasing public infrastructure investments, cutting taxes on technology-oriented domestic products) may boost the economy and create new jobs. The central bank could also loosen its monetary policy to the extent permitted by the interest rate decisions of the Fed and other major central banks.

Long-run policies are more important to boost economic growth and put Turkey back on a prosperous path. In the long-run, Turkey needs to further increase its technology and productivity level. It should also reduce the high dependency of its manufacturing industries on foreign inputs, in order to increase value-added growth and to reduce the current account deficit. To make this happen, Turkey should encourage more R&D and innovation activities by strengthening the link between research and business applications, improving the business and investment environment and boosting the quality of its universities. Turkey also needs to attract high-tech foreign direct investments to close its technology gap.

Turkey should encourage more R&D and innovation activities by strengthening the link between research and business applications.

The current situation in Turkey’s main export markets indicates that Turkey has to further diversify its export markets by focusing more on East Asian, African and Latin American countries. Therewithal, in order to sell more goods to existing export markets, Turkey should diversify its products, especially high-tech ones such as software, microelectronics, nanotechnology, biotechnology and information and communication technologies.

Finance plays a critical role here, as it allows firms to adopt more recent technologies, to conduct more R&D, to introduce new products to the market and to export more. To reap the benefits of financial markets, you should first fuel them. Although foreign capital is an alternative, channeling domestic savings to the financial markets is the most appropriate way of fuelling financial markets for developing countries. With that said, the current savings rate in Turkey is inadequate. Gross domestic savings as a percentage of GDP is about 13% in Turkey. High domestic savings played a key role in the East Asia Miracle. China and India followed a similar path by saving more than 25% of their income, just as Japan and South Korea did in the past. To invest more in physical capital, human capital and R&D activities, Turkey should increase its domestic saving rate. Diversifying financial investment opportunities is a way of increasing domestic savings. Supporting private equity and venture capital and increasing Islamic finance products such as sukuk might encourage savings in Turkey. Policy makers should take some steps that encourage banks to focus more on credits to SMEs and technology based firms rather than on household credits.

Turkey needs to grow at least 5 percent per year on average in order to achieve its medium and long-term economic targets.

Education reform is another necessity for Turkey. Although Turkey is making progress in educational attainment, the average number of years of schooling remains only 7.6. With its human capital stuck at this level of education, Turkey cannot transform the structure of its economy based on technological and high value-added products. Turkey needs to increase both quantity and quality of its education. As the results of the Program for International Student Assessment (PISA) indicate, Turkey has lots of room to improve students’ math, reading and science skills. In addition, the education system in vocational schools and universities should be revised based on the needs of the Turkish economy. Broadening access to apprenticeships and internships, and increasing the quality of these practical trainings are also necessary to benefit more from the human capital of Turkey’s large young population.

Turkey needs to grow at least 5 percent per year on average in order to achieve its medium and long-term economic targets. But, the new ab-normal state of the global economy and geopolitical risks have put a number of obstacles in Turkey’s economic development path. Therefore, Turkey should carry out these necessary reforms as soon as possible in order to pass this stretch of bumpy road without slowing down too much. Decoupling from a global economic trend is a difficult task; achieving it requires implementing reforms in a systematic, coordinated and decisive way. Turkey did a good job in implementing first generation reforms. Why not again?

The life of any successful policy is not indefinite and inflation targeting is not an exception. Therefore, it is necessary to discuss alternative policies and targets that will not only provide price stability, but also contribute to economic growth.

Thanks to the measures taken by the CBRT, the BRSA and other public institutions, the Turkish economy stood firm against the Global Financial Crisis (GFC), which shook the global economy in 2008. The CBRT used various mechanisms to support the liquidity of the financial system and revive credit markets, including lower interest rates. The CBRT has used macro-prudential policies instead of micro-prudential ones; the former have helped to immunize the side effects of the GFC.

Turkey has made important advances in its financial and monetary markets. However, there are certain areas that create vulnerabilities for the Turkish economy. As discussed above, the CBRT has adopted inflation targeting regime since 2002. At the beginning of the 2000s, Turkey’s first priority was to maintain macroeconomic stability. Reducing inflation was one of the key aspects towards achieving this. Therefore, the inflation targeting regime, which was popular across the world, was crucial in reducing inflation in a stable manner. Inflation targeting was in the forefront of the policies proposed by the neoliberal paradigm.

However, inflation targeting’s shortcomings appeared over time. Many economists, including Joseph Stiglitz and Jeffery Frankel, emphasize the failure of inflation targeting after the GFC. Although central banks have tools, such as increasing policy interest rates, to reduce demand-pull inflation, this is not the case with cost-push inflation. Central banks have limited power to affect inflation when increasing oil and/or food prices are the main reasons for soaring inflation. But, even in the case of cost-push inflation, many central banks increase their policy interest rate to achieve inflation targets. This policy not only fails to reduce inflation, but also reduces economic growth and increases unemployment.

Unfortunately, the CBRT could not achieve its inflation targets in recent years mainly due to supply shocks and to other factors that were beyond its control. The CRBT, however, continues to maintain its high interest rate policy despite the fact that it fails to keep inflation down. Although one of the main reasons for keeping interest rate very high is to prevent the excessive depreciation of the Turkish lira, the CBRT has been criticized frequently in recent times for its policy.

The life of any successful policy is not indefinite and inflation targeting is not an exception. Therefore, it is necessary to discuss alternative policies and targets that will not only provide price stability, but also contribute to economic growth.

The global economy is experiencing one of its most tumultuous periods in history. Turkey needs to move beyond this period with the minimum deviation from its medium and long-term economic goals. If Turkey can achieve this, it will be faster in catching up with developed countries. Otherwise, Turkey will have to wait longer to join the so-called “convergence club”. Of course, monetary policy alone cannot promote economic growth. Yet, we need to take economic growth into account when implementing the former.

We live in very different times now: there is intense debate about the “new normal” of global economy and the central banks of developed countries under the “extraordinary measures in extraordinary times” slogan are using unconventional monetary policies that nobody would have dared to propose ten years ago.

We live in very different times now: there is intense debate about the “new normal” of global economy and the central banks of developed countries under the “extraordinary measures in extraordinary times” slogan are using unconventional monetary policies that nobody would have dared to propose ten years ago. Perhaps it would be better for the CBRT to adopt a new monetary policy framework in which it will pursue complementary objectives like price stability and strong economic growth.

A dual mandate and nominal GDP targeting are two alternative options that are more growth-friendly. In the dual mandate, the CBRT will not only target inflation, but also unemployment rate. Since unemployment rate is an important indicator of economic activity, it gives us important signals about the economic growth.  If this option were to be followed, the CBRT should take into account both inflation and unemployment rate when it decides its policy interest rate and when it makes use of other monetary policy instruments. When the domestic or global economy face challenges, the CBRT will prioritize growth by rigidly reaching its unemployment target; when the economy overheats, the CBRT will focus more on inflation.

The Federal Reserve System (Fed), the central bank of the United States, is a good example of a dual mandate. First, the Fed has an inflation target of 2%. Second, it has a maximum employment target, which is not constant but changes according to economic projections. Nowadays, the Fed tries to keep unemployment around 4.8%.

The second policy option is nominal GDP targeting. Under this option, the CBRT will respond to shocks by taking into account both inflation and the level of GDP. When there is a supply-shock such as a sudden increase in oil and food prices or a natural disaster, the central bank will not increase policy interest rate as this will not reduce cost-push inflation, but will reduce GDP. Therefore, the central bank will not increase interest rate in order to achieve the nominal GDP target. The situation is the same when there is an adverse trade shock.

It is clear that Turkey needs a new central banking framework. Current policies under inflation targeting do not respond to Turkey’s needs.

It is clear that Turkey needs a new central banking framework. Current policies under inflation targeting do not respond to Turkey’s needs. Academics, politicians, bureaucrats and representatives of the financial sector should discuss potential options that will further support Turkey’s efforts to reach the upper steps of the economic development ladder. If one of the aforementioned options seems more suitable for the Turkish economy, the government should think about changing the law defining the central bank’s responsibilities. But, we should also keep in mind that monetary policy is not a panacea.

Monetary policies implemented by developed countries after the GFC couldn’t restore insipid economic growth. A monetary policy will be helpful in smoothing out fluctuations in prices and economic activity, but it cannot bring about long-term growth. Structural reforms, smart industrial policies and a sound fiscal policy are necessary for long-term economic growth. A well-founded monetary policy can only play a supporting role.