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Turkey: Inter - Temporal Model and Exchange Rate Analysis

1) The document discusses Turkey's inter-temporal model and exchange rate analysis. It notes that Turkey has a GDP of $771.4 billion but a GDP per capita below the world average. 2) It analyzes Turkey's balance of payments data from 1989-2018, noting its current account deficits fit the Metzler model but financial account deficits contradict it. 3) It discusses Turkey's recession in 2018-2019, caused by global economic slowdown reducing exports and rising US interest rates, as well as internal factors like debt burden from currency depreciation.

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Lena Phan
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246 views16 pages

Turkey: Inter - Temporal Model and Exchange Rate Analysis

1) The document discusses Turkey's inter-temporal model and exchange rate analysis. It notes that Turkey has a GDP of $771.4 billion but a GDP per capita below the world average. 2) It analyzes Turkey's balance of payments data from 1989-2018, noting its current account deficits fit the Metzler model but financial account deficits contradict it. 3) It discusses Turkey's recession in 2018-2019, caused by global economic slowdown reducing exports and rising US interest rates, as well as internal factors like debt burden from currency depreciation.

Uploaded by

Lena Phan
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPTX, PDF, TXT or read online on Scribd
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Turkey

INTER –TEMPORAL MODEL AND EXCHANGE RATE ANALYSIS


Inter-temporal model: The case of
Turkey
 Turkey is a developing country (IMF)
GDP = 771.4 billion USD; rank 19th
GDP per capita = 9,370 USD < world average, rank 74th
 Inter-temporal model:
Chances for Poor country’s GDP growth > Rich countries
 Poor countries have a comparative advantage in future
goods
 Rich Countries will current goods for claims on future goods
 Net resource flow from Rich to Poor  Poor country is net
borrower with CA deficit and FA surplus
Turkey’s BoP (1989-2018)
20

(20)
• Current Account deficit  fits
Metzler model
(40)
• Financial Account deficit 
contradicts Metzler model
(60)
Explanation:
(1)Oversea returns >
(80)
domestic interest rate
(2)Government policy
(100)
(3)Turkey is not a poor
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
country
Current account balance (BoP) Financial Account balance (BoP)
Net lending (+)/ net borrowing (-)

Source: World Bank


Turkey Recession 2018
 Period: Q4-2018 to Q2 -2019
 External Causes:
 Global economic slowdown reduce demand for Turkish exports
 Rising world’s interest rates: US Fed raised interest rate
 Trade war: US raised tariff on Turkish steel to 50%
 Internal Causes:
 Overheating economy fueled by foreign credits
 Debt burden rose as the local currency depreciated
Response to crisis
1. An increase in the world interest rate
Current account deficit will reduce
r I
S'
S
2. A decrease in current income
Leftward shift in the savings schedule,
As households must spend more of
their income on current consumption.
CA will deteriorate.

0
S, I
I 1’ S 1’
Turkey’s economic data (2018-2019)
70.00 350.00

60.00
300.00
50.00
250.00
40.00

30.00 200.00

20.00 150.00
10.00
100.00
-
50.00
(10.00)

(20.00) -
Q1-2018

Q2-2018

Q3-2018

Q4-2018

Q1-2019

Q2-2019

Q3-2019

Q4-2019
Source: OECD & CEIC data
Purchasing Power Parity

 Purchasing power parity (PPP): people in all countries have


the same purchasing power with their currencies  exchange
rate is determined by levels of average prices
 Absolute PPP : E = P/P*
P and P* are level of average prices at home and in the foreign
country, respectively
 Relative PPP: (Et – Et –1)/Et –1 = t – *t
where t = inflation rate from period t –1 to t
Turkey & United States
70%

60%

50%

40%

30%

20%

10%

0%

-10%

-20%

Change in forex Inflation Differential

Source: Federal Reserve Bank of St.


Louis
PPP in long-run

 Change in exchange rate: average 2.68%/month


 Inflation differential: 2.41%/month
 PPP holds in the long run between Turkey and US.
 Possible causes of deviation:
• Non-tradable goods
• Trade barriers
• Home bias
Turkey & United States
70%

60%

50%

40%

30%

20%

10%

0%

-10%

-20%

Change in forex Inflation Differential

Source: Federal Reserve Bank of St.


Louis
PPP in short -run

 PPP does not hold in the short run


 Reason for deviation:
 Exchange rates adjust quickly (almost instantaneously), while
good prices adjust slowly.
 Distance
 Trade barrier
Exchange rate event

 July 31, 2019: Fed cut interest rates by 0.25%


 First reduction in borrowing costs since the 2008 financial crisis
 Reasons: weak global growth and US-China trade war had
impacted growth of US economy
 Investors reacted negatively, warning that this cut is not
sufficient to stimulate economic growth
 Economists expected further cuts in future
What happened in each market

Changes in the Foreign Market


o The reduced interest rates in the US results in an increase in
the supply of dollars and reduces the expected rate of return
on dollar deposits.
o This reduction in the expected rate of return on dollar deposits
causes the dollars to depreciate.
Changes in the Home market
No change in the Turkish money market due to the change in the
supply of dollars.
Effect on exchange rate
Lira/USD
exchange rate Lira return

Increase in US money
1’ supply (cut in dollar
Effect of an ↑ in the US Money Supply  𝐸 1❑ interest rate)
2’
on the Lira/Dollar Exchange Rate  𝐸 2❑
Expected dollar return

Rates of return (in


0 lira terms)
𝑅  1 𝐿𝑖𝑟𝑎
𝑆 L()
 
 𝑀 𝑇𝑢𝑟
Turkey’s real money
𝑃 𝑇𝑢𝑟 1 supply

Turkey’s real
money holdings
Exchange rate history
6.10

6.00

5.90

5.80

5.70

5.60

5.50

5.40
May-19 Jun-19 Jul-19 Aug-19 Sep-19 Oct-19 Nov-19 Dec-19

Source: Federal Reserve Bank of St.


Louis
Long-run effect on exchange rate
Lira/USD Lira return
exchange rate

 𝐸 1❑ 1’
3’
Effect of an ↑ in the US Money Supply  𝐸 3❑ 2’
on the Lira/Dollar Exchange Rate  𝐸 2❑
Expected dollar return

Rates of return (in


0 lira terms)
𝑅  1 𝐿𝑖𝑟𝑎 𝑅  3 𝐿𝑖𝑟𝑎
𝑆 L()
 
 𝑀 𝑇𝑢𝑟
Turkey’s real money
𝑃 𝑇𝑢𝑟 1 supply

Turkey’s real
money holdings

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