Economic Crisis and Stabilization Decisions Launched in Turkey

The economic crisis is the deterioration in an economy that occurs unexpectedly and with great severity which significantly affects the economic activity. More precisely, the economic crisis is the unexpected and severe deviations in real and financial indicators.

These relations are measured by using international goods flows (foreign trade); international service flows (tourism, transportation, consultancy, etc.); international factor flows and international capital flows. These transactions are also known as the balance of payment items. The magnitude of the international economic relations of countries can also determine the speed and severity of the crisis from country to country.

Financial Crises are major disruptions in financial markets that are characterized by sharp declines in asset prices and the failures of many financial and nonfinancial firms so that the markets are unable to channel funds efficiently from savers to people with productive investment opportunities. As a result of this inability of financial markets to function efficiently, economic activity contracts sharply. While a disturbance in financial markets is reflected in asset prices immediately, it takes time for it to reflect on real markets. Therefore, we can say that financial crises turn into economic crises with a certain lag.

The financial system fulfills a very important function in the economy. This function is to transfer funds from people with no productive investment possibilities to those with productive investment possibilities. When the financial system does not perform its fundamental function effectively, certain bottlenecks occur, resources cannot be transferred to productive areas and the production capacity of the economy falls. Consequently, financial difficulty or a financial crisis leads to a serious deterioration in the real economy (on the production and distribution side).

There are four different financial crisis definitions depending on the source to distinguish them. These are currency crisis, banking crisis, systemic financial crises, and sovereign debt crisis.

The banking crisis may arise from the institutional structures of banks, namely their high leverage balance sheets, macroeconomic shocks, risky banking transactions, intense competition, poor management, institutional weakness and dependence on short-term foreign resources and as well as from bank runs (also called as a run at the bank).

The overlap of the banking crisis and the currency crisis is called the twin crisis. The damage caused by the twin crises is more severe than a single crisis.

The sovereign debt crisis is the government’s failure to pay internal and external debts belonging to the public and private sectors. Sovereign debt crises occur when the combination of the level of a government’s debt and the prospects of continued fiscal deficits couple to raise doubts about its ability or willingness to pay off all of its obligations at face value.

According to this model, currency crises depend on the fixed exchange rate system, the economic policies implemented by the government, and the behavior of the currency speculators.

The most important feature that distinguishes the second generation crisis model from the first generation is that even if the fundamentals are strong, the speculative attacks could trigger economic crises. Even if there is no deterioration in fundamentals, the expectation of investors that the currency will be devalued can create a self-feeding speculative attack, and this triggers a currency crisis. The second generation of crisis models emphasizes the importance of multiple equilibria. These models show that doubts about whether a government is willing to maintain its exchange rate peg could lead to multiple equilibria and currency crises.

Orthodox economic policy is a term that refers to the application of conventional and traditional economic policy (monetary and fiscal policies). These policies do not contradict the logic of the market economy as they are experienced policies and they are also expected by the economic units. Orthodox stabilization programs are recommended to countries to overcome high inflation and balance of payments problems in the 1950s and 1980s.

The design of orthodox stabilization programs combines contractionary monetary and fiscal policies under a fixed exchange rate system. Demand is reduced by reducing the fiscal deficit, decreasing the growth rate in the money supply, lowering the currency, and stopping subsidizing economic activities. Supply is enhanced by decontrolling and reforming prices to allow for the more efficient market allocation of investment and other resources.

Heterodox stabilization programs implement tight monetary policy, tight fiscal policy that is also launched in orthodox stabilization programs, and temporary income policies (what is meant by the income policy is the control of wages and prices for a certain period of time) to achieve rapid and sustained disinflation. In other words, heterodox stabilization programs are a combination of orthodox stabilization programs and income policies.

The difference between the 24 January 1980 decision and the previous ones was to abandon the import substitution industrialization policy and adopt the export-oriented industrialization policy and to minimize government interference in the economy by making the free market economy work in the Turkish economy.

The public income and expenditure imbalances and consequently increased borrowing and rising interest rates which were the chronic problems of the Turkish economy; fragile banking sector that was the root of the crisis; demand rise for both foreign currency and Turkish Lira; speculative movements, current account deficit, political instability, and deferred structural reforms.

The problematic structure of the banking sector played an important role in the outbreak of the November 2000 and February 2001 crisis. At that time, the banking sectors’ liability was much higher than their assets in terms of foreign currency, meaning that the open positions of the banks were quite large. Another problem of the banking sector was the mismatch of the maturities between the assets and liabilities. Hence, the banking sector was so vulnerable to both increasing the exchange rate and the interest rate. On the other hand, the equity ratios of both public and private banks were very low.

The main purpose of TSEP was to quickly eliminate the insecurity and uncertainty that arises due to the abandonment of the exchange rate regime, to create modern institutional structures in order not to experience similar crises, to make structural reforms that provide economic efficiency, to use macroeconomic policies effectively to reduce inflation, to ensure sustainable economic growth and reduce income inequality.

The economic crises in both developed and developing countries not only increased but also spread very quickly from one to another country and dragged another country into an economic crisis. Because after the 1990s, the capital moved very quickly and freely through the diversity in financial instruments especially derivative instruments and the development of communication technologies after the 1990s.

Some economic and political developments, such as the rising interest rates in developed countries as a result of the tight monetary policy practices, political instability and political assassinations which raised risk premium on Mexican assets and the expectation that the Peso would be devalued in 1994, caused a huge amount of capital outflow in a short time. Increasing capital outflows drastically reduced the foreign exchange reserves, and an economic crisis occurred in 1994 in Mexico.

The 2008 global economic crisis also known as the global financial crisis arose when subprime mortgage loans, which were opened to low-income people in the USA in 2007, began to default at a high rate. These defaults caused a high rate of foreclosures, deteriorated banks’ balance sheets and caused a credit crunch where the banks became short of funds. As a result, the banking crisis occurred in the USA and, with the collapse of the investment bank Lehman Brothers in September 2008, it turned into an international banking crisis. Soon after, it affected the whole world.