FIW-Spotlight: Turkey’s risky monetary policy experiment

The Turkish economy has been struggling in recent years, experiencing rapid depreciation of the lira and a surge in inflation. While this may appear to resemble the emerging market difficulties of the 1990s, and also partly reflects the inflationary pressures affecting all of Europe at the moment, the underlying mechanisms are distinct and mostly self-inflicted. The recent economic situation in Turkey, the 6th most important trade partner for the EU with 3.3%, serves as a stark reminder of the consequences of mishandling monetary policy.

The European Union continues to be Turkey’s largest export and import partner (Figure 1) despite a declining trend in the recent years. Between 2018 and 2022, Turkey’s export share to the EU decreased from 43.1% to 40.5%, while the import share dropped from 33.3% to 25.6%. Austria represents a smaller portion of Turkey’s overall trade: Turkey’s export share to Austria remained relatively stable at around 0.7% over the last years, the import share however dropped from 0.7% in 2018 to 0.5% in 2022.From the European perspective, Turkey is the 6th most important trading partner for the EU with 3.3%. Turkey’s share in Austrian trade is about 0.7% (incl. intra-EU trade).

Over the past decade, Turkey has faced a combination of challenges including unstable growth rates, significant currency devaluation, and surge in inflation (Figure 2). In recent years, the issues have worsened, partially due to external factors such as the COVID-19 pandemic and the war in Ukraine, leading to very imbalanced pattern of growth and a significant accumulation of potential risks within the economic system. Turkish unconventional monetary policy, characterized by low interest rates and heavy reliance on credit, has played a significant role in exacerbating these issues. With President Erdogan securing another term, concerns over the direction of the monetary policy are stronger than ever and raising alarms for the future stability of Turkey’s economy.

However, it is important to note that the economic landscape hasn’t always been this way. In fact, during the first 10 years of President Erdogan’s rule, both he and the AKP were widely regarded as capable, conservative, and careful in their approach to economic policy. Yet, from the mid-2010s, Turkey started grappling with significant challenges. Political risk increased, such as due to Gezi Park protests in 2013 and coup attempt in 2016. Partly in response to this, the government started to erode the capacity and independence of state institutions. 

In an effort to counter the economic slowdown during that period, the government implemented measures such as substantial infrastructure investments and low interest rates to encourage domestic borrowing (Figure 3). The impression increased that the central bank was being forced to keep interest rates low. However, these measures resulted in significant trade deficits, increased reliance on external credit, rapid depreciation of the lira, and a loss of confidence in monetary policy driven by prolonged periods of negative interest rates and mounting inflationary pressures.

Turkish monetary policy experiment as a cure for slowing growth and increasing inflation

Central bank independency in Turkey has been on decline in recent years. President Erdogan’s actions indicate that he does not hesitate to dismiss central bankers and finance ministers if they do not comply with his wishes. Since 2020, three officials were dismissed from their positions without a clear explanation, sparking speculation that their refused to lower interest rates may have been the primary reason for the termination[1]. President Erdogan believes that higher interest rates are the cause of rising prices, not a cure for them. He argues that keeping interest rates low will encourage consumer spending, business investment, and job creation. He also claims that a weaker Turkish lira against the US dollar would make exports more affordable, leading to increased demand from foreign consumers.

There is some truth to his arguments. The weaker lira does seem to have helped export growth in the last couple of years. And cheap credit has certainly supported consumer spending. Yet these policies entail significant consequences. Turkey heavily relies on imports such as fuel, gas, medicine, fertilizer, and other raw materials. When the value of the lira declines, the cost of purchasing these goods increases. Additionally, President Erdogan’s unconventional monetary policy has raised concerns among foreign investors who were previously willing to lend substantial amounts of money to Turkish businesses. Furthermore, implementation of lira saving scheme “KKM”, a state-backed foreign exchange-protected deposit, is transferring the risk of exchange rate fluctuations to the public sector, giving a rise to substantial contingent liability, and posing a risk for domestic financial stability.

At the beginning of 2022, when central bankers in Europe and the United States started to adapt tighter monetary policies by raising interest rates to tackle inflation, Turkish Central Bank started lowering its interest rate. This unconventional strategy has led to sharp depreciation of the lira and ever-more elevated inflation rates, with the year-on-year inflation rate reaching a 24-year high of over 85% in October 2022. Many analysts believe that the actual inflation rate on the streets is even higher than the official figures suggest [2].

To counter the impacts of surging inflation, the Turkish government has implemented several measures. These include raising the minimum wage and public worker wages by 55% and 45%, respectively. Beside the introduction of KKM scheme, the government has also enforced strict regulations on foreign-currency transactions conducted by companies. However, the effectiveness of these measures appears to be limited. As of April 2023, Turkey’s annual inflation rate was 43.7%, showing a downward trend due to base effects, but still extremely high compared to peer countries.

Rising inflation rates in Turkey, along with an increase in import prices and production costs, create major difficulties for households and businesses alike. Low-income households struggle to afford basic necessities as prices skyrocket, while businesses find it challenging to plan and invest in new projects due to unpredictable returns and mounting costs. In Turkey, just like in any other country, inflation is influenced by factors related to both demand and costs. Therefore, raising interest rates alone would not address the issue. It is essential to also keep in mind cost factors such as higher energy prices. Yet it remains clear that as long as real interest rates are deeply negative, the lira will depreciate, imported inflation will surge, and the economy will suffer.

What does the future hold?

With President Erdogan securing another term in office, immediate changes to monetary policy following the elections are unlikely. However, considering President Erdogan’s history of policy changes, and the pressure of the weakening lira and high inflation on the economy, a change of course is possible. If the central bank does raise interest rates, this would not be the first time that it has abruptly changed course; something similar happened in 2018 and 2020. The timing of any reversal will depend on the economic consequences of the current policies. If the lira continues to decline, the state’s contingent liabilities, linked to KKM and other potential risks will escalate. Thus, it remains plausible that adjustments may be made.

Accurately assessing demand and cost factors remains crucial for effectively managing inflation and utilizing interest rate policy in Turkey. A change in the monetary stance to something more orthodox, targeting small positive real interest rates, would not solve all of Turkey’s economic problems but certainly improve macroeconomic stability and provide the basis for a more stable growth rate. However, even without this, the economy has shown itself remarkably resilient. If foreign funding continues to arrive to plug the large current account deficit, it is likely that the year 2023 will end with a growth rate of around 2.6% and an inflation rate ranging between 40-50%, gradually easing the pressure on the exchange rate throughout the year.

[1] See Reuters (2021), Factbox: Revolving door: Turkey’s last four central bank chiefs, available at and CNBC (2021), Turkey’s Erdogan names Nebati as new finance minister as lira skids, available at

[2] See DW (2022), Inflation in Turkey: Researcher won’t hide the figures Erdogan doesn’t want to see, available at, and Euronews (2022), Soaring inflation and a collapsing currency: Why is Turkey’s economy in such a mess?, available at


Meryem Gökten is Economist at the Vienna Institute for International Economic Studies (wiiw) and country expert for Turkey. Her research focuses on macroeconomic analysis, fiscal policy, and monetary policy. Prior to joining wiiw, she worked as a researcher in the Financial Markets and Institutions Unit at Centre for European Policy Studies (CEPS), and as a consultant in the Country and Financial Sector Analysis Division at the European Investment Bank (EIB). She holds a master’s degree in economics from University of Freiburg and bachelor’s degree in economics from University of Heidelberg.

Richard Grieveson is Deputy Director at wiiw and Research Associate at the Diplomatic Academy of Vienna. He specialises in the economies of Central, East and Southeast Europe, with a particular focus on Turkey and the Western Balkans. Previously he worked as a Director in the Emerging Europe Sovereigns team at Fitch Ratings and Regional Manager in the Europe team at the Economist Intelligence Unit. He holds degrees from the universities of Cambridge, Vienna and Birkbeck.

The interactive graphics were created by Alireza Sabouniha. He is a research assistant at wiiw and a master’s student in Economics at the WU (Vienna University of Economics and Business).