By Oguz Senbayrak
Turkey’s economic behavior contrasts with classical models, with rising inflation sometimes increasing demand due to speculative buying. Traditional policies, like raising interest rates, struggle to balance inflation and unemployment. Heavy borrowing and reliance on imports amplify inflation, creating long-term instability risks that demand structural reforms.
In most economies, as inflation rises, demand tends to fall—at least that’s what classical economic theory suggests. The basic premise, rooted in rational consumer behavior, is that when prices go up, people buy less. However, in countries like Turkey, this relationship doesn’t always hold. Instead, a unique blend of inflationary pressure and consumer habits has led to economic behavior that defies standard models.
In developed economies, consumer behavior is generally more predictable. As the Consumer Price Index (CPI) climbs, demand for goods with high income elasticity, like luxury items, tends to drop. But in Turkey, we see a different story, rising prices don’t instantly prevent demand.
Stagflation and Turkey’s Economic Reality
Traditionally, economists have relied on the Phillips Curve to explain the relationship between inflation and unemployment. The theory suggests that as inflation rises, unemployment falls and vice versa. However, Turkey’s current economic situation tells a different story. Although stagflation isn’t present now, unemployment remains above desirable levels despite being at a decade low, and this trend is expected to persist. Contributing factors include rising labor costs and capital outflow from the industrial sector.
In this complex environment, traditional monetary policies, such as raising interest rates, struggle to manage inflation without worsening unemployment. In Turkey, the challenge is particularly serious as inflation fails to reduce demand, and in some cases, it seems to encourage speculative buying.
Turkey’s “Rational” Irrationality
Consumer behavior in Turkey exhibits a form of “rational irrationality.” Initially, as the CPI rises, demand holds steady. But beyond a certain threshold, demand for goods—especially those consumers fear will become even more expensive—actually increases. This behavior, driven by inflationary expectations, leads to “speculative buying!” and “stockpiling!”. Fundamentally, consumers are trying to protect themselves from the risk of future price hikes.
However, this speculative demand is a double-edged sword. While it might drive consumption in the short term, it pushes borrowing to unsustainable levels, as credit card debt and consumer loans escalete. Turkey’s reliance on borrowing to maintain consumption levels, especially in the face of high inflation, creates a risky cycle that threatens long-term economic stability.
Debt Dynamics and the Risk of Financial Instability
Turkey’s borrowing boom is reflective of economic theories such as Hyman Minsky’s Financial Instability Hypothesis. Minsky argued that extended periods of growth and rising borrowing lead to financial crises. Turkey’s current situation fits this pattern, with consumer debt rapidly rising even as inflation eats away at purchasing power.
One significant factor worsening Turkey’s economic instability is the relationship between domestic and international interest rates. As long as real interest rates in Turkey remain lower compared to those in the US and Eurozone, despite any rate cuts in these regions, demand for foreign currency will likely exceed demand for the TRY. In a high-inflation environment, low real interest rates make foreign currency more attractive, putting upward pressure on the exchange rates. This dynamic can further weaken the TRY and increase the demand for foreign currency, complicating the country’s economic recovery.
Due to the increase in interest rates, it is crucial to carefully monitor the adverse effects of the increasingly difficult access to financing in Turkish lira. This situation could lead to issues such as rising financing costs and slowed economic growth. Additionally, the high budget deficit remains a risk factor. The budget deficit may limit the government’s ability to maintain economic balance and could lead to increased borrowing. The rise in borrowing during a period of restricted access to financing highlights the need for structural reforms. These reforms are essential for ensuring economic stability and supporting growth. Failure to implement structural reforms could worsen economic problems and threaten long-term economic stability.
The mismatch between debt growth and income is particularly concerning. Credit cards and consumer loans have been used to fuel short-term consumption, but this strategy is unsustainable. As borrowing costs rise and inflation continues to reduce real incomes, a tipping point is inevitable.
The Vicious Cycle of Inflation and Borrowing
Turkey’s heavy reliance on imports further complicates the picture. As exchange rates rise, the cost of imported goods skyrockets, driving up CPI and fueling cyclical inflation. Consumers, aware of this trend, prefer to convert their savings into goods rather than keeping them in the form of cash, exacerbating inflationary pressures.
This behavior is reminiscent of historical hyperinflation cases, such as 1920s Germany and 2000s Zimbabwe, where people rushed to buy goods, fearing that money would lose value too quickly. In Turkey, this pattern is feeding a vicious cycle of inflation, where speculative demand outpaces supply, leading to even higher prices.
Looking Forward: Navigating an Uncertain Future
Turkey’s economic landscape is complex, and solutions are far from simple. While speculative demand and borrowing have driven consumption in recent years, this trend cannot continue indefinitely. At some point, the capacity to borrow will run out, and demand will fall, potentially leading to economic contraction.
The Turkish government faces a challenging balancing act. Policies aimed at curbing inflation, such as raising interest rates, must be carefully calibrated to avoid triggering a debt crisis. At the same time, structural reforms are needed to reduce reliance on borrowing and shift the economy toward sustainable growth.
Turkey’s situation is a cautionary tale of the delicate balance between inflation, consumer behavior, and borrowing. While the short-term effects of speculative demand may keep the economy afloat, the long-term risks of financial instability loom large.
About the Author
Oguz Senbayrak is a Senior Consultant, specializing in market liquidity and interest rate risk management. With a background in economics and an MBA in progress, he has extensive experience in financial risk management, derivatives, and speculative market behavior, making him an expert on inflation dynamics and consumer behavior in emerging markets.
