Everything that has been written and told about inflation during the recent turmoil in Turkish financial markets has to be refined, before constructing new inflation expectations. Otherwise, inaccurate evaluations regarding the inflation inertia could lead market players to subscribe into wrong anticipations about inflation, and more importantly fuel a false set of expectations from the monetary authority. Our aim here is to make the picture clearer with the help of detailed analysis of the inflation data, which will help to separate the urban myths from the facts. In summary, we first argue that before the recent volatility, inflation was not rising. Second, we show that although demand was on the rise, it was not creating a remarkable upward pressure on prices and thus was not a threat for reaching the medium term inflation target. Then, we claim that one should not expect demand pressure to push up prices in the next 12 months on the back of the weaker TRY and the rise in interest rates. Depending on these observations, we believe that even if we see higher-than-expected inflation in the next two months (CPI heading towards 13%), the remedy is NOT TO hike short term policy rates further. The only justification for further rate hikes would be to build credibility. Putting further constraint on consumption will be unyielding on the inflation front, while it halts the economy. Finally, we claim that what is required for price stability and inflation deceleration is currency stability. Sometimes this can be secured by rate hikes, but there are times when direct intervention in the FX market is inevitable. Although FX interventions should not be the main policy instrument of an inflation targeting Central Bank, they may be required during bad times, particularly when demand for hard currency is irresponsive to an increase in interest rates. Currency risk is, obviously, a risk for investors, but the monetary authority cannot be indifferent to a severe depreciation of the currency since the exchange rate is still an important factor determining inflation. Neither the output gap arguments, whose impact on inflation is weak and statistically insignificant, nor legislative measures can be as instrumental as the stability of exchange rates to curb inflation expectations. |