Question 7(a)
Sources for use with Section B
The economy of Turkey
Figure 1 Central bank base interest rate, January 2018 to December 2020
25
20
15
%
10 8.25
5
0
Jan July Jan July Jan July Jan
2018 2018 2019 2019 2020 2020 2021
Figure 2 Rate of inflation, as measured by the Consumer Price Index (CPI),
January 2018 to December 2020
30
25
20
% 15
11.76
10
5
0
Jan July Jan July Jan July Jan
2018 2018 2019 2019 2020 2020 2021
Figure 3 Turkish lira–US dollar exchange rate*, January 2018 to December 2020
10
8
6
Lira per
US dollar
4
2
0
Jan July Jan July Jan July Jan
2018 2018 2019 2019 2020 2020 2021
* Turkey’s currency is known as the Turkish lira
Extract A Currency depreciation
Turkey’s President, who controls the Central Bank of Turkey, is an opponent of high
interest rates. He dismissed the Central Bank’s previous Governor in 2019, complaining
that “he would not follow instructions on interest rates”. The Central Bank made a series
of interest rate cuts after a new Governor was appointed. The President wanted a 5
reduction in interest rates to encourage borrowing by businesses and consumers in order
to stimulate Turkey’s rate of economic growth.
By contrast, some economists urged the Central Bank to raise interest rates to slow
the pace of credit growth and to avoid a currency crisis. They argued that following
the reduction in base interest rates, there was a further fall in the exchange rate of the 10
Turkish lira against the US dollar. Turkey’s large current account deficit and capital flight
have also contributed to the depreciation of the Turkish lira. Attempts to increase the
external value of the lira while keeping interest rates low have reduced most of the
Central Bank’s foreign currency reserves. Economists warned that the risk of a financial
crisis in Turkey was growing. 15
In response, the new Governor of the Central Bank of Turkey raised the base interest rate.
This increase indicated that the Central Bank was concerned about the weakness of the
lira and a high rate of inflation. By December 2020 the base interest rate had increased to
17%. However, some economists argued that the Central Bank would need to raise the
base interest rate further to support the weak currency. 20
Turkey’s long-term economic growth will depend on attracting foreign direct investment
and establishing a stronger partnership with the European Union (EU) which is a customs
union and common market. Turkey is an important partner for the EU on matters related
to trade, investment and migration. Governments of many EU countries believe that they
have an economic interest in developing a mutually beneficial relationship with Turkey. 25
With reference to Figure 1 and Figure 2, calculate Turkey's real interest rate in July 2020. You are advised to show your working.