Is there really an interest rate lobby?

Is there really an interest rate lobby?

Is it possible to use interest rates for many aims, i.e. to control monetary expansion for the sake of price (and/or financial) stability or on the contrary to stimulate economic activity? Yes, this is possible. However, as written in every macroeconomic textbook, it is not possible to use a single macroeconomic policy tool for many purposes at the same time.

This means that interest rates can be used to control inflation or to stimulate economic activity or, as recently practiced, to control hot money inflows; but not all of them. The reason is obvious: The results of all these practices contradict each other. To avoid these contradictions, it is better to use a policy tool only for a single aim. 

A short while ago, Prime Minister Recep Tayyip Erdoğan talked about the presence of an interest rate lobby, whose members advocate high interest rates to increase their speculative gains. Then a new discussion began on whether lower interest rates were possible, feasible and useful for the economy instead of higher rates. 
First of all, it must be understood that even interest rates have some serious influences on markets: The level of interest rate is an outcome, not the main reason of movements on those markets. It means that when authorities decide to use interest rates as an economic policy tool, first they must take into consideration what the markets indicate. 

A majority of businesspeople, economists and politicians are uneasy about hot money inflows. Although recent data has indicated a positive development in the current account deficit, the comparatively high ratio of the deficit to gross domestic product still causes pessimistic comments on the vulnerability of the economy. 

Many emerging economies are trying to solve this problem by levying new taxes on foreign transactions, by raising reserve requirements and even by intervening directly into the foreign exchange markets. However, all these attempts seem unsuccessful in stopping hot money inflows into their financial markets. 

It might be considered that lower interest rates while encouraging new investments also put a brake on short-term capital inflows, stop the overvaluation of the national currency and, as a result, encourage exports and discourage imports. Thus, foreign trade and current account deficits will be narrowed. In addition, new investment will guarantee the continuation of strong growth.

However, there are other aspects of the problem. Lower interest rates will not only encourage investments but also consumption and rapid increases in both expenditures might give a push to inflation. During the first phases of that process, a mild inflation for a strong growth is generally forgiven. However, various past experiences, especially in Turkey, proved that it has been almost impossible to control inflation later on, even if a mild one is permitted at the beginning.

It is not easy to deal with these dilemmas for both the Central Bank and the government, especially in the middle of a worldwide crisis. The recent acts of the Central Bank to control increase in bank credits, hot money inflows, the current account deficit and inflation at the same time seems to be a very difficult task. Again, it must be remembered that it is impossible to use a policy tool for many contradicting purposes.

One last word: The prime minister mentioned there might be an interest rate lobby in Turkey, as there are many in various countries. However, it must be accepted also that those who believe higher interest rates are an effective tool to control inflation are not necessarily members of that lobby.

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