Türkiye's Homemade Crises

Türkiye's response to post-pandemic inflation is a cautionary tale of how political pressure for low interest rates can create macroeconomic instabilities. While central banks worldwide raised interest rates to combat inflation in 2021-2023, Turkish authorities pursued the opposite strategy: cutting real rates to deeply negative levels while implementing financial engineering tools, FX interventions, and financial repression to stabilize markets. The centerpiece was a novel FX-protected deposit scheme (KKM) that guaranteed depositors against currency depreciation, shifting exchange rate risk to the government balance sheet. We provide a detailed account of this policy experiment and develop a theoretical model focusing on how KKM functions and creates vulnerabilities. Our model reveals that pressure to keep interest rates below inflation-targeting levels can lead to an interconnected destabilizing sequence. Low rates generate inflation, current account deficits, and exchange rate depreciation. KKM provides partial stabilization by effectively raising rates for savers while maintaining low rates for borrowers. However, this creates growing contingent fiscal burdens and vulnerability to self-fulfilling currency and sovereign debt crises. This explains additional policies adopted including capital flow management, financial repression, and return to orthodox monetary policy. As central banks worldwide face renewed pressure to set lower policy rates, Türkiye's experience illustrates the consequences.