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Recently, President Erdogan sacked the head of Turkey’s central bank because he didn't want to cut interest rates. He even said: “We said that if rates fall, inflation will fall. He didn’t do what was necessary.”

From my understanding of economics, this is the opposite of how things work. If we want to lower inflation, we should raise interest rates even further. So why President Erdogan is conviced of the opposite? Is there a sound economic theory that would agree with Erdogan's initiative?

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    $\begingroup$ I'm not sure this is answerable within the scope of this site. You're asking for insight into the mindset of someone, with no reason to believe that that mindset is based on any sound economic theory. $\endgroup$ – EnergyNumbers Jul 18 at 2:48
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    $\begingroup$ What I want to know is: is there a sound economic theory that would agree with Erdogan's initiative? $\endgroup$ – Victor Jul 18 at 5:36
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    $\begingroup$ I think his question is fine... he clearly states the situation, and asks why a counter intuitive measure is being taken. The politician doesn't really have anything to do with it, although it's good to have for background context. $\endgroup$ – Clinical_Coder Jul 18 at 13:31
  • $\begingroup$ The question "Is there a sound economic theory that ....?" is fine, and the first paragraph is useful context. But I suggest that the question "So why President Erdogan ...?" be deleted, and the title edited accordingly. The question would then be suitable for this site. $\endgroup$ – Adam Bailey Jul 18 at 18:37
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I'm gonna start this off by saying this is speculative, so take this answer with a grain of salt.

In order for a counter intuitive measure like this to work, there must be something else going on that over-shadows it. (Inflation topics tend to be riddled with things like this). I admit I don't know what the economic climate in Turkey is like currently; but I can think of a way that it would make sense to lower rates and expect lower inflation.

In light of recent events, Turkey has been the focus of some very negative media coverage as of late, and some of it for good reason. The last couple years for Turkey have been rough to say the least; but that's not the macro-trend of Turkey. Turkey is an emerging market economy, they have urbanized dramatically from 2000-2015, maintained strong macroeconomic and fiscal policy frameworks, opened up to foreign trade and finance, harmonized many laws and regulations with European Union (EU) standards, and greatly expanded access to public services. It also recovered well from the global crisis of 2008/09.

Tying this back to your question now, it could be the case that Turkey's government spends too much money and is the biggest factor in the inflation numbers. If President Erdogan can better enable the people of Turkey to replace the effect of government spending organically (enable the people via lowering interest rates), then he can purposely scale back government spending (which would lower inflation b/c it's the bigger factor).

In summary: Erdogan may be trying to stabilize Turkey's economic climate via lower government spending which will reduce aggregate demand, leading to lower growth and less demand pull inflation. The macro trend of Turkey and forecasted growth expectancy is very high, and probably over heated, despite the recent negative issues in the micro economic climate.

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It is true that (standard) economic theory says that cutting interest rates will lead to higher inflation but there actually exists an empirical phenomenon called the price puzzle which says the opposite: Lower interests rates are associated with lower inflation in the short-term (anywhere from a a couple of quarters to a couple of years). References: https://files.stlouisfed.org/files/htdocs/publications/net/20061001/cover.pdf and https://pdfs.semanticscholar.org/4263/679d36e13d79cb8cf675768a21e53b22fc73.pdf

There is a good chance this is not what Erdogan is referring to but the empirical inconsistency certainly is interesting. Note that the consensus (as far as I know) seems to be that the price puzzle can be 'removed' by 'correctly' specifying the empirical model, such that lower interest rates don't actually causally imply lower inflation.

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Well, I don't know the specifics of Turkish economy enough to venture whether what Erdoğan says makes sense in situ or not.

But while cheap credit will likely devaluate currency and therefore rise inflation, it stands to reason that loans are costs to individual industrial/commercial/agricultural firms. If those are in deep debt and the cut in interest rates allows them to renegotiate their debts, it is possible that they will have more cash to pay for other expenses and to invest, resulting in an expansion of production and consequent fall of prices. Besides, of course, slashing part of their costs may allow them to lower their prices.

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