The stakes are too high

Why Trump and Erdogan declared war on central banks: economist Sergey Khestanov explains

During the era of the gold standard, there was no need for much regulation of monetary policy - gold cannot be printed. But with the abandonment of the gold standard, the role of central banks has increased dramatically.

Today, the idea that the Central Bank should be independent of both the executive and the legislature is a classic. In countries with a developed judicial culture and a low level of corruption, the independence of the Central Bank has become an unwritten law. The executive branch is very often tempted to use pressure on the Central Bank to manipulate monetary policy for its own purposes.

The most typical example of this kind of pressure is the requirement to lower the key rate to revive economic activity in the country. In an export-oriented economy, executives often insist on weakening the national currency to stimulate exporters.

Recently, pressure on central banks has been increasing around the world, and this is happening in countries that are absolutely different from each other in terms of the development of public institutions. Two, perhaps, the most polar examples: the USA and Türkiye. Despite all the differences of these countries, their presidents strongly demand that their monetary authorities lower the key rate to stimulate economic growth.

At the same time, the requirements regarding the exchange rate differ diametrically opposite: Trump insists on the weakening of the US dollar, and Erdogan on maintaining the stability of the Turkish lira and curbing inflation.

It is noteworthy that the President of Turkey puts forward simply amazing theories that a high key rate ... causes inflation!

The entire previous experience of all the central banks of the world says exactly the opposite. However, this did not prevent Erdogan from dismissing the head of the Turkish Central Bank, citing the fact that he did not support the government's economic policy.

The reasons that prompt Erdogan to act so rudely (and in the long run - irrationally) are simple and understandable: the economy is falling (GDP - 2.6% over the past quarter), inflation is growing (15%, and it was 25%), the Turkish lira is devaluing (one and a half times in just a year), unemployment is growing (already 14%), and the incomes of the population are noticeably falling, and after that, the popularity of Erdogan and his party. The past municipal elections clearly showed the fall in popularity - the candidate from Erdogan's party lost in Istanbul after a re-vote.

Something urgently needs to be done, and Erdogan decided to take up monetary policy! A small and short-term effect from a rate cut can be obtained, but short-term positive effects are followed by negative, and much longer-term ones: inflation, devaluation, capital flight and dollarization (refusal to use the national currency in general).

The chances of repeating the Venezuelan scenario are growing sharply. And so far, everything points to a high probability of just such a scenario in Turkey.

Mr. Trump's motivation, on the other hand, is hard to understand. The US economy shows good growth rates: 3% is an unattainable dream for modern Russia, unemployment is at a very low level. The elections are still far away, and there is no urgent need for a rate cut yet. It is far more prudent to keep the key rate high, so that there is room to lower it in case the next cyclical crisis comes. However, the United States has a fairly effective system of separation of powers, so even Trump is unlikely to be able to do something terrible.

What unites these two completely different precedents of pressure by heads of state on the Central Bank is economic populism. Such cases show that decisions in the field of monetary policy must be made very carefully: it is easy to lose the confidence of investors and domestic citizens, but it is both difficult and long to restore it.

Alas, in the economy there are no simple and easy recipes for solving problems. And for those recipes that seem so, you have to pay very dearly.