Turkey's economy struggles with high interest rates amid idle labor

Turkey's economy is caught in a difficult bind, requiring high interest rates to fight inflation while simultaneously grappling with significant underemployment.

The author explains that economic policy often focuses on inflation, suggesting interest rates should rise with prices. However, central banks also consider production capacity. In Turkey, these two factors are pulling in opposite directions: inflation demands higher rates, while unused labor suggests lower rates.

Official unemployment figures hover around 8%, but a broader measure of underutilized labor, including those unable to find sufficient work or on the fringes of the job market, reveals a much larger problem, affecting nearly 30% of the workforce. This "idle labor" represents untapped production potential, leading to a "negative output gap" where the economy produces less than it could.

Normally, a negative output gap would signal room for lowering interest rates to stimulate production. However, Turkey's persistent inflation, coupled with expectations about future price increases, currency fluctuations, and ingrained pricing habits, makes such a rate cut impossible. The economy needs lower financing costs to employ its idle workforce but must maintain high interest rates to control prices, creating a fundamental policy conflict. The author also notes that measurement issues in inflation data could further complicate these economic calculations.