Tag Archives: interest rate

Fed: interest rate hikes soon?

The economy has shown moderate recovery since the height of the financial crisis back in 2008. This was in part due to the monetary policy goal of the Fed by setting interest rates lower and lower until they could not anymore, hitting the zero lower bound. With short-term interest rates at just about 0% since December of 2008, the US has had a real interest rate that is very low/negative with the goal of encouraging spending in the present and discounting the future a lot more. Any talk of raising the interest rates during this weak economic time would have not taken seriously. That is until now where the discussion seems to have legitimacy, based on where the Fed believes we are on track in the recovery stage.

Recently released meeting minutes reveal that Federal Reserve members have brought up the interest rate topic during their policy meetings. Some of the policy “hawks” (those who consider inflation control as a leading issue) expressed concern over a potentially overheating economy if hikes were not made. This would be a continuation of the Fed winding down its recovery. Just last month, we saw the Fed cut its bond purchases by $10 billion. The Atlanta Fed President Dennis Lockhard has said, “I expect the asset purchase program to be completely wound down by the fourth quarter of this year.”

Mr. Lockhart also said on Wednesday he remains “comfortable” with his forecast that the Fed won’t raise short-term interest rates until the second half of 2015, provided the economy strengthens as he expects.

 At 6.5% unemployment, the Fed claimed to begin the talks of raising inflation. The current unemployment is 6.6%, leading some to believe that a rate increase is not far beyond the horizon. These higher than expected drops in unemployment have been partially speculated to due to a disproportionate number of elderly retiring, removing them for the labor force pool and thus the unemployment numbers.

Despite all possible what-ifs, I think this is showing some great news about the US economy. For as long as I’ve understood or cared enough to listen about economic news, we’ve been in or recovering from this crisis. It’d be interesting to finally be in a world with a bolstering economy. As funny as that my be to some who remember leading up to the financial meltdown, there are also concerns as the policy “hawks” at the Fed have mentioned about an overheating economy. Concerns over the nonconventional economic recovery tools (i.e. QE) may loom in the coming years. Spending is now longer as encouraged as saving inflationary times.

Malaysia Central Bank’s Decision

In ECON 411 –Monetary and Financial Theory class, we learned how effective negative real interest can be in order to stimulate the economy from recession. By setting long term inflation rate around 2 percent and setting nominal interest rate near zero, negative real interest rate can be achieved as shown by the Fisher Equation. US, Japan and many other countries used this in order to stimulate the economy when financial crisis occurred in past years.

Wall Street Journal article (Rising Inflation in Malaysia Turns Up the Heat on Central Bank) points out Malaysia’s recent monetary policy and its outcome. Data which came out on Wednesday showed that consumer price rose to 3.4% in January from a year earlier. Malaysia’s economy did grow at a strong rate past few years, and now Malaysia’s central bank is planning to raise the interest rate from 3.00% to 3.25 % as a measure of bringing the price level down. According to Wall Street Journal article (Malaysia’s Central Bank Stands Pat Again), Malaysia have been keeping its nominal interest rate at 3.00% for last three years. Due to its relative low interest rate compared to its inflation, Malaysia could achieve a fast economic growth, maintaining GDP growth rate of 4.7% in 2013 when many other countries suffered from the turmoil.

Malaysian government started to slow down its government spending, which might decrease domestic demand. Central bank’s decision of increasing interest rate could also reduce domestic demand. However, economists forecast that Malaysia can still achieve strong GDP growth of 5.0% to 5.5% this year, thanks to its strong export.

Malaysian central bank’s decision of increasing interest rate is a smart decision to hold inflation rate and curb dangers of overspending and control debt as well. When I read the articles and thought of Malaysia’s decision, I related this to US’s tapering of quantitative easing. US, although its unemployment rate is not meeting government’s goal, started to taper as US did achieve some economic recovery in recent years. “Tapering” is as important as “quantitative easing,” as economy could be over-stimulated and over-inflated and it could be very dangerous. Malaysia showed how effective “negative real interest rate” is, from its ongoing GDP growth. If Malaysia can also show how they can control inflation and prevent “over-stimulating” the economy while keeping its economic growth strong just like economists have forecasted, it will be a good example of how negative real interest rate is a good, non-harmful stimulus for economic growth.

Why Foreign Reserve is No Longer Cherished in China

One of the cliche in Economic world is that China is now the NO.1 creditor in the world, with a total of $3.48 trillion of foreign reserve under its belt.(according to last year end statistics).But this huge amount of foreign reserve is really an ostentatious number that really couldn’t be less valuable than a “hot potato” .

The People’s Bank of China said the country does not benefit any more from increases in its foreign-currency holdings, adding to signs policy makers will rein in dollar purchases that limit the yuan’s appreciation.

This might sound exaggerating and counterintuitive—how could $3.48 trillion of assets as miserable as a “hot potato” for China?

Foreign Reserve has become a “hot potato” because it has been causing China huge amount of loss each year. How can owning foreign reserve cost money? Well, this is because China hold foreign reserve in the form of U.S. Treasury Bills, which are essentially a bunches of IOUs yielding zero return (the U.S Treasury Bills hit the zero lower bound during 2008 and is still not yet rebound). Now how could foreign reserve in the form of T-Bills end up with negative yield? It turns out that we omitted one important part in our previous discussion of foreign asset yield. Any foreign asset yield compose of two parts—exchange rate fluctuation and interest rate.  While China holding the zero yielding T-Bills,  Dollar also depreciate over time against Yuan.  Thus, the real rate of return for China’s reserve assets in the form of T-Bills is essentially negative.

According to the China’s International Investment Position in 2013, there is further expansion of net foreign assets, but still negative investment returns: Net outflows of $21 billion under the financial account, the addition of $97 billion to official reserves and a $44 billion upward adjustment in the valuation of existing assets abroad lifted China’s net foreign assets from $1.69 trillion at the end of 2011 to $1.74 trillion in 2012. Despite this hefty net surplus in foreign assets, China remains a net interest payer to the world due to lower rates of return on its overseas assets.

Figure13

Apart from the low yielding feature, another reason why more reserve is no longer in China’ s interest is because foreign reserve has caused domestic inflation.(more details of this causal relationship has been discussed in my previous post.)

This is really counterintuitive since we all have the preconceived notion that being a lender is better than being a borrower. In our day to day life, being a lender means having the right to claim interest on the property lent out. Property right is protected by legal system of a particular country. However, in a global setting where two nations contend with each other and act according to its best interest, there is no such thing as property right.( Or else we wouldn’t see a bunch of wars happened here and there throughout history). If a country default, the worst thing could happen to that country is that it will face with a war. But there is no guarantee that the country should pay back the debt in the future if he does not want to or does not able to.

Now this is exactly what happened to China. China has been holding a bunch of low yielding IOUs in dollar term. And If U.S. were to default once China offer to sale the assets, there isn’t much option for China to choose but to accept whatever the outcome.

It is interesting to look back why China initially valued dollar foreign reserve. Back to old day when China just open up its market to the world and get involved in international economic arena, dollar was extremely valuable. China has been hoping that in the future they can use this money to buy advanced technology that will help its own economy development. However, U.S. and other developed countries hold technology that has strategic significance credential. Therefore, China has been left only the option of  investing in T-Bills and other low yielding assets.

Thus, the once popular dollar reserve  is no longer cherished in China.

 

Yellen’s Debut

On Tuesday, Janet Yellen set course for steady bond-buy cuts. The Federal Reserve plans to keep winding down bond buying unless the economy takes another decline. Ms. Yellen believes that some recent economic data has been soft, in that she thinks the drop in labor-force participation is more structural than cyclical. Her reasoning behind this is that many baby-boomers have reached their time to retire, so we can expect a large proportion of Americans to be retiring at the same time.

Ms. Yellen served on the committee that helped formulate the current bond buying/tapering strategy, so she strongly supports this strategy. Before being sworn in last week, she had been the Fed’s vice chairwoman for more than three years. In her position as vice chairwoman, she pushed aggressively for the Fed to adopt easy-money policies and encouraged borrowing, spending, investment, and hiring. However, she suggested through her comments that she plans to gradually move away from these policies as the economy improves.

Later in her speech, Yellen articulated that she anticipates economic activity and employment to expand at a moderate rate this year and next. She anticipates the unemployment rate to continue to decline toward its longer run sustainable level and inflation will move back toward 2 percent over the coming years. Touching again on the drop in labor force, Ms. Yellen suggested that we use more than the unemployment rate when evaluating the current state of the United States labor market because those out of a job for more than the past six months make up an unusually large fraction of the unemployed. More factors contributing to the current unemployment rate are the high rate of adults working part time who want full-time jobs and also the number of Americans who lack the confidence to leave their jobs. (see below)

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Moreover, Yellen also spoke about the Fed’s internal debate over how much weight to put on the unemployment rate as it drops. In December, they said they wouldn’t raise short-term interest rates from near zero until unemployment fell to 6.5%. It fell to 6.6% in January…

In my opinion, I believe that the slowdown in bond purchasing is great. However, I do believe that we will face problems once inflation levels fall short of the Fed’s 2% target. This scenario relates back to the discussion that we had last class, where some inflation is always necessary in order to get leeway on the zero lower bound. With the unemployment rate quickly approaching the 6.5% threshold, it will be interesting to see how the Fed will react.

Thought on Forward Guidance: Proposal for the Fed

The FED has been pursuing its so called “forward guidance” program hoping it could stimulate economy by convincing the persistence of low interest rate policy. It stated that it sees the current low interest rate appropriate as long as the unemployment rate remains above 6.5% and the expected inflation in one to two years is below 2.5%. According to the statement, it will consider the broader labor indicators and inflation expectations to decide how long it will continue the near zero interest rate policy once the unemployment rate drops to 6.5%. Therefore, it is very up in the air when the FED is increasing the federal funds rate.

We know that the latest report shows the unemployment rate is 6.6%.  This rate indicates that even though the monthly net number of jobs added hasn’t been up to the projections for last two months, the FED will soon be deciding its future policy and writing up its well-into-future forward guidance once the unemployment rate hits 6.5%.

After all, the FED’s low interest rate policy has been directed toward increasing investment. But there could be different type of “forward guidance” that could potentially create more investment as the FED wishes. My proposal to the FED is that:

a) It should forward guide the market by putting hard deadline on when it is increasing the federal funds rate and therefore the market interest rates. How this clear deadline for increase in federal funds rate works is following: If the FED successfully (!) convince the market that it will indeed push up the federal funds rate, the investors will have clear expectation of when the overall market interest rates are rising. Therefore, realizing the higher investment cost in the specific future, firms will have incentive to borrow and invest today before the FED raises the interest rate. Hence, the investment could increase as the FED has been wishing. This argument is analogical to the people’s consumption when there is very high inflation expectation. If the expected inflation is very high, people would try to buy goods as soon as possible. But the one difference between these two analogies is we don’t know what interest rate is very high to be analogy to the high inflation rate.

One might say that then if there is higher demand for loanable funds because of this policy, the interest rate will rise in the loanable funds market. But we have to remember, the FED has control over overall interest rate in the economy (or I believe so), it will pursue its current near zero interest rate policy until the date it forward guided comes.

b) Again, to succeed in increasing investment, the FED must be able convince the market that it is indeed increasing the federal funds rate at that certain date, To convince the market, the FED should set the date to be in near future and interest rate minimally higher in first few periods and commit to what it said.

According to latest report, the expectation of the FED’s federal funds rate in June 2015 has lowered in a recent month. This might be showing that the FED’s forward guidance indeed successfully convinced the market that the FED will be pursuing near zero interest rate policy. If current forward guidance is indeed somewhat successful, I believe the proposed forward guidance could be also successful.

Remember, at the time when the FED sets the specific date to increase the interest rate, the interest rate will be still zero percent, therefore there will be no negative shock to the total investment.

The problem to implement this forward guidance is that the FED cannot surely know how bad or good the economy will be performing at the time of its forward guided date. The FED could announce its first date to increase the interest rate once the unemployment rate reaches 6.5%. If the FED chooses 3 months to increase the federal funds rate after the unemployment reaches 6.5%, it can study how the investment behaved during this 3 months when the market believes the increase in the interest rate is coming. If the sign turns out to be good, the FED can further implement this “hard deadline for minimal increase in federal funds rate” forward guidance.

Is there a way out for private firms in China?

Chinese companies have never defaulted on debt. But this year we could expect a first time. “We keep guessing when we will see the first bond default in China and I think it might be possible to see one or two cases this year,” said Mr. Wang from Shanghai Yaozhi Asset Management, which oversees two billion yuan in assets.

The increasing debt in China has been heralding a crash down of financial systems, although the exact date of which we don’t know yet. But at least the news of ever rising repayment rates of corporate bond signals that day is getting closer.

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How on earth would corporate debt become a issue?

As discussed in my last post, China major banks have a long-established tradition of prioritize lending to state-owned enterprises and state-initiated investment projects. Thus it is always extremely hard for private firms to get credits from formal banking systems. As central bank PBOC rose reserve deposit ratio again and again to combat inflation, formal banks faces cash shortage to the extend that they could barely settle inter-bank lending.

Now what would small firms do if they don’t get credits? There are three ways for them to raise money. First, they can resorts to illegal credit resources, such as non-bank financial institutions, who normally charges higher rate due to higher risk of operation.  Second, they could raise funds through IPOs, which is what causing the stock markets in China to plunge recently. Third, they could raise funds through issuing corporate bonds.

As Chinese government scrutinizing on shadow banking and restricting IPOs, many firm resorted to the third approach. However, bonds issuing firms like Evergreen seems to again running out of ammunitions, as bond repayment rate rises again and again.

In June 2012, Evergreen paid 4.64% when it borrowed 400 million yuan for one year. Seven months later, issuing one-year debt cost it 6.13%. In December, it had to pay 9.90% to borrow the same amount, giving Evergreen the distinction of paying the highest coupon rate for any new short-term corporate bond since the government launched the market in 2005, according to WIND Info, a data provider.

Why would corporate bonds yield rises? This is because bond rate is structured based on the risk neutral bonds( i.e government bond) plus a risk premium. According to recent news, China’s first auction of government bonds this year resulted in a 16-year-high yield of 4.47% for the five-year debt. Chinese bonds rates started rising around mid-2013 in tandem with reduced liquidity in China’s money market, partly triggered by the central bank’s efforts to enforce a tighter monetary policy that is aimed at reining in financial risks associated with local-government debt and shadow banking.

It seems that Chinese government is shooting on its own feet again and again. If only China could stop the state-initiated investment projects and let banks lend money freely and competitively to industries with higher returns, the problem of cash shortage, shadow-banking would be solved.  Then logically, they wouldn’t need to rise bank interest rate again and the long term bonds rate wouldn’t need to rise to attract buyers. This would in turn help private firms funded by bonds to reduce their financing costs. Now the situation is reversed. I couldn’t think of how hard it is for Chinese private firms like Evergreen to survive in such a harsh situations.

I could only hope if their is a fourth way for private firms to raise money. God bless them.

 

 

 

 

What Unemployment Rate Doesn’t Say

Let’s assume that proposed minimum wage increase to $10.10 is signed. Then according to very basic upward sloping supply curve, we would expect more labor supply. That means, there would be more people entering to the labor force from the pool of discouraged workers. These entering people wouldn’t find a job quickly. Therefore, there will be some upward movement in unemployment rate.

The point of this post is that if the minimum wage indeed increases and the unemployment rate increases, that isn’t necessarily be a bad, and the increase in minimum wage shouldn’t be blamed as much. On the other hand, the increase in minimum wage could overturn discouraged workers into labor force, and I believe that is not a bad.

Of course, there might be a direct effect of the increase in minimum wage on unemployment because companies would have to fire some workers when the minimum wage increases (I believe that is what people who are against the minimum wage increase are saying). What I am suggesting is that let’s not fully blame an increase in minimum wage if there is to be higher unemployment rate after this change in wage.

This argument is just to show that any certain change in only unemployment rate doesn’t tell the whole story on whether the economy is performing well. If we look at the recent unemployment rate which came out on Friday morning, 6.6% of unemployment is a good news for the economy. As I said on higher minimum wage’s effect on labor force participation rate, this change in unemployment rate could be caused by people going out of or getting in the labor force. In December’s job report, the decrease in unemployment rate from 7% to 6.7% as the economy gained 75,000 more jobs was mostly due to the increased number of people dropping out of labor force.

Also, this one number called unemployment rate doesn’t tell us enough information because it is an aggregate rate over the U.S.. The WSJ article nicely sums up this point:

“We have multiple unemployment rates—by race, gender, geography and above all educational attainment. When people talk of an unemployment crisis, it would be more accurate to speak of an education crisis or a crisis of men whose skills are mismatched to today’s jobs. It would be more accurate to speak of a jobs crisis in specific regions of the country or for specific industries. Yet we maintain the collective fiction that one simple average accurately captures multiple realities.”

The WSJ article says that we have to consider the employment rate as we discuss economic condition. The recent job report shows another improvement in terms of increased employment-population ratio. The ratio increased to 58.8% in January, which is the highest level since August 2009, but it is well below pre-recession level of 63%.

As the unemployment rate goes down faster than expected, another news we are watching is whether the FED will increase its federal funds rate because of a decreasing unemployment rate.  The FED’s January meeting statement says:

The Committee also reaffirmed its expectation that the current exceptionally low target range for the federal funds rate of 0 to 1/4 percent will be appropriate at least as long as the unemployment rate remains above 6-1/2 percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee’s 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored.

This policy of low interest rate as long as the numbers are within the range has been re-evaluated. The FED’s same statement reads:

The Committee now anticipates, based on its assessment of these factors, that it likely will be appropriate to maintain the current target range for the federal funds rate well past the time that the unemployment rate declines below 6-1/2 percent, especially if projected inflation continues to run below the Committee’s 2 percent longer-run goal.

What we can tell from this FED’s change in policy view is that the FED doesn’t give any meaning for the 6.5% of unemployment. Pointing out some number is just the FED’s way to increase their credibility and convince the public that it will maintain its low interest rate policy. The FED, seems like, didn’t expect the unemployment rate would fall down to this rate this quickly. It will be interesting to see what target rate the FED will choose if they continue the low interest rate policy even though the unemployment rate falls below 6.5%.

In conclusion, even though unemployment rate is one of the main economic data we look, it hides so much of what is happening in the economy. Therefore, we shouldn’t draw quick analyze from the rate.

Change in Expected Inflation and Its Effect on Investment and Spending

Greg Mankiw explained a possible tool for the FED to stimulate the economy under zero lower bound. He says that even the FED has already lowered the federal funds rate to close to zero, the monetary policy that creates a higher expected inflation in the economy could boost the economy. Mankiw explains that if the expected inflation is increased due to the FED’s policy or other reasons, the real interest rate can be lowered. According to this argument, this lower real interest rate induces more investment because of negative correlation between real interest rate and investment. In his words:

“Other economists are skeptical about the relevance of liquidity traps and believe that a central bank continues to have tools to expand the economy, even after its interest rate target hits its lower bound of zero. One possibility is that the central bank could raise inflation expectations by committing itself to future monetary expansion. Even if nominal interest rates cannot fall any further, higher expected inflation can lower real interest rates by making them negative, which would stimulate investment spending.”

How I see this argument is this: since a firm expects that the overall price in the economy to increase by more than  what it expected before, the firm would invest more in new capital than it was planning to do for two reasons: first, it would try to take advantage of low price more than it was planning before. In other words, since the firm expects the general price to go higher than it expected before, it will increase its today’s investment to avoid paying this higher price in the future to buy capital. It is shifting its investment from the future to today. Second, when the firm’s expectation of inflation increases, it would seek to borrow more money than it planned to do because the real interest it will pay in the future decreases. In other words, they just cannot resist this lower real interest rate in the future; therefore, they will borrow money today and invest in whatever plan they could think good.

The part I don’t understand in Mankiw’s argument is how the change in expected inflation could affect the real interest rate today.

In his General Theory, Keynes writes:

“The expectation of a fall in the value of money stimulates investment, and hence employment generally, because it raises the schedule of the marginal efficiency of capital, i.e., the investment demand-schedule; and the expectation of a rise in the value of money is depressing, because it lowers the schedule of the marginal efficiency of capital. (p.142)

Keynes says that any possible affect of the increase in expected inflation on the investment is through the higher schedule of the marginal efficiency of capital. What I am understanding as the schedule of the marginal efficiency of capital is the firms demand for investment.

Now on the effect of higher expected inflation on consumption spending, it seems to be reasonable to expect that people would spend more today if their expectation on the general price rises. Of course, whether it is true or not depends on in what time period we are talking about the inflation expectation. If people raises their expectation of inflation in the near future, they try to adjust their spending accordingly. Also, the effect on consumption differs for durable goods and non-durable goods since the absolute change in the prices of durable goods tend to be higher than that of non-durable goods. Because of this possible effect on the spending, there could be increase in overall prices today. In other words, a higher expected inflation could cause increase in prices today. However, this possible positive relation between the change in expected inflation and spending isn’t clear. In their paper in 2012, Bachmann et al concludes following: 

“We find that the impact of inflation expectations on the reported readiness to spend on durable goods is statistically insignificant and small in absolute value when compared to other variables, such as household income or expected business conditions. Moreover, it appears that higher expected price changes have an adverse impact on the reported readiness to spend. A one percent increase in expected inflation reduces the probability that households have a positive attitude towards spending by about 0.1 percentage points. At the zero lower bound this small adverse effect remains, and is, if anything, slightly stronger.”

We still lack empirical study on the effect of the change in expected inflation on the spending. In my curiosity, I looked over some data on the monthly change in the expected inflation, quarterly percent change in the investment and monthly percent change in consumption spending. fredgraph (1)   From this graph, we cannot tell whether the higher expected inflation induces more investment or higher consumption spending. Of course, we need to do empirical research to claim whether it is true or not. In conclusion, I don’t see or understand the stimulating effect of the higher expected inflation on the economy as Mankiw and others see it. Therefore in my opinion,  the effect of raising inflation expectation by monetary policy, which is one of the two main tools that some people suggest in today’s case of zero lower bound problem, isn’t clear. The other tool, quantitative easing, seems to be more effective under zero lower bound.

Fed Winds Down the Bond Purchases

The Federal Reserve announced that it would continue to slowly dismantle its stimulus campaign, citing “growing underlying strength in the broader economy”. As stated in Wall Street Journal, the Fed officials have become more optimistic about the U.S. economic outlook in the past few months. Though job gains slowed in December, the growth rate of gross domestic product appears to have accelerated to well over 3% in the second half of 2013.

As posted on The New York Times, stock indexes fell Wednesday as the Fed’s retreat rippled through global markets, making the money toward less risky investments like Treasury securities. Despite the positive effect on American economy, there would be some negative impacts on the global market. This action would have influence on global investment patterns as investors who look for higher returns in foreign markets are beginning to anticipate the return of higher interest rates in the United States. Countries like Turkey, depending heavily on foreign investment, would face a lot of problems. On the other side, investors seeking to control their risks are bidding up the price of Treasury bonds, which would offset the effect of the Fed’s gradual reduction in the volume of its own purchases. The problems in Turkey would somehow help to hold down interest rates in Omaha.

Dated back to September 2012, the third in a series of efforts also known as quantitative easing (QE). This program was to hold down long-term interest rates to spur borrowing, spending and investment. For now the Fed doesn’t see signs that it is spilling over into a larger problem that could damage the U.S. financial system or economy.

I agree that the clear Fed default position is to continue tapering. The Fed also keeps short-term interest rates near zero as it has been since late 2008. As we learnt in today’s lecture, the relationship between inflation rate and unemployment rate was negatively related that in order to keep the unemployment rate low, the inflation rate should be relatively high. Given that the current U.S. unemployment rate is quite high,  Fed officials repeated the message that they will likely keep rates at that low level “well past” the point at which the unemployment rate reaches 6.5%. The Fed had earlier set that as the threshold for starting to consider rate increases, as long as inflation remains in check.

Standing at the current point, I praised that Fed officials have made a great decision in dealing with the domestic economy. Let us keep following on the effects following by the Fed’s decisions.

 

 

 

Turkey’s Woes

Turkey’s economy has seen large growth throughout the past few years due the Fed keeping US interest rates low.  Investors fled US treasury bonds in search for higher yields in Emerging markets, leading many emerging market countries to live outside of their means due to increases in foreign investment and borrowing.  With the Fed announcing recently to further increase tapering, leading to rising interest rates in the US, that easy capital and investment that was flowing to markets like Turkey, Indonesia and South Africa, is now leaving just as quickly as it arrived.  The flight of capital from these countries have led to the speculative bubbles in emerging-market currencies to finally pop, leading to a rapid drop in emerging market currencies versus the dollar.  The Turkish Lira has recently weakened to 2.244 per dollar even after the Turkish Central Bank increased interest rates from 4.5% to 10% and overnight lending from 7.75% to 12%.  South Africa and India have also recently increased interest rates in hopes of stemming the weakening of their respective currencies.  A lot of people place the blame of capital flight to and from emerging markets at the feet of the Fed due to their low interest rate policies after the recession and the tapering that is now being undertaken.  I believe though that Turkey’s issues stem more from its political and social unrest and its poor macroeconomic conditions and as the global economy improved, countries who were living beyond their means due to the slow down of developed economies, would eventually come crashing back to reality.

Turkey’s economy though has faced corruption allegations and political unrest following its economic slowdown in 2012.  Normally, interest rate hikes can help stabilize currencies, but Turkey’s political unrest has led to investors to ignore the rate hike and focus more on the political situation and slowly growth instead.  Investors are weary that the government will put pressure on Turkey’s central bank while it is trying to create support for the government while it is embattled with corruption charges.  The central bank increasing interest rates would lead to slowing growth which would lead to job and prosperity issues as well as falling consumer demand which would likely cause Turkey’s government to lose more of the public’s sympathies.  The fight now in Turkey is what’s more important, the Government winning elections in 2015 or protecting Turkey’s long term economic viability by protecting its currencies.  We will see which one plays out as the month continues.  If Turkey’s central bank can withstand political pressure from the government, then there is a chance for a painful, but safer recovery due to maintaining a stable currency and inflation by manipulating the interest rate.  Unfortunately, I believe that Turkey’s government and president have too much power and will continue to cause investors to flee Turkey.  Right now, Turkey’s political unrest is the main reason investors are still fleeing even though the interest has been increased.