AHMET BAYRAKTAR & CENGIZ SAATCIOLU 2001461033 2000461159

INFLATION AND IMF STABILIZATION PROGRAMMES IN TURKEY

WHAT IS INFLATION? Simply put, inflation is a situation in the economy where, there is more money chasing less of goods and services. In other words, it means there is more supply/availability of money in the economy and there are less of goods and services to buy with that increased money. Thus goods and services command a higher price than actual as more people are willing to pay a higher value to buy the same goods. In this inflationary situation, there is no real growth in the output of the economy per se. Its simply more money chasing few goods and services. THE BASIC TYPES OF INFLATION Demand-Pull Inflation Demand-pull inflation places responsibility for inflation squarely on the shoulders of increases in aggregate demand. This type of inflation results when the four macroeconomic sectors (household, business, government, and foreign) collectively try to purchase more output that the economy is capable of producing. In terms of the simple production possibilities analysis, demand-pull inflation results when the economy bumps against, and tries to go beyond, the production possibilities frontier. Then end result is inflation. In the more elaborate aggregate market analysis, demand-pull inflation results when aggregate demand increases beyond aggregate supply creating economy-wide shortages. As with market shortages, the price (or price level) rises. Then end result is inflation. Cost-Push Inflation Cost-push inflation places responsibility for inflation directly on the shoulders of decreases in aggregate supply that result from increases in production cost. This type of inflation occurs when the cost of using any of the four factors of production (labor, capital, land, or entrepreneurship) increases. In terms of the production possibilities analysis, this means that the production possibilities frontier is shrinking closer to the origin, causing it to bump down against the aggregate demand. Then end result is inflation. In the aggregate market analysis, aggregate supply decreases to less than aggregate demand creating economy-wide shortages. As with any market shortages, the price (price level) rises. Then end result is inflation. The Inflation Rate and the Price Level The inflation rate is the percentage change in the price level. The formula for the annual inflation is Current years Price level Inflation rate Last years price level WHAT ARE THE WAYS OF MEASURNG INFLATION? Consumer Price Index (CPI) -- This measures the consumer prices of a basket of commodities in different cities. Wholesale Price Index (WPI) -- This measures the different prices of a basket of commodities in the wholesale markets. The basket is broadly made up of Primary products, Fuel products, and manufactured products. GDP Deflator --This is used to adjust measure of gross domestic product for inflation. CAUSES OF INFLATION Inflation may be caused by an increase in the quantity of money in circulation. This has been seen most graphically when governments have financed spending in a crisis by printing money excessively, often leading to hyperinflation where prices rise at extremely high rates. Another cause can be a rapid decline in the demand for money as happened in Europe during the black plague. The money supply is also thought to play a role in determining levels of more moderate levels of inflation, although there are differences of opinion on how important it is. For example, Monetarist economists believe that the link is very strong; Keynesian economics by contrast typically emphasize the role of aggregate demand in the economy rather than the money supply in determining inflation. A fundamental concept in such Keynesian analysis is the relationship between inflation and unemployment, called the Phillips curve. This model suggested that price stability was a trade off against employment. Therefore some level of inflation could be considered desirable in order to minimize unemployment. The Philips curve model described the US experience well in the 1960s, but failed to describe the combination of rising inflation and economic stagnation (sometimes referred to as stagflation) experienced in the 1970s. Another Keynesian concept is the natural gross domestic product, a level of GDP where the economy is at its optimal level of production. If GDP exceeds its natural level, inflation will accelerate as suppliers increase their prices. If GDP falls below its natural level, inflation will decelerate as suppliers attempt to fill excess capacity. Is Inflation Good For The Economy? Yes and No. Yes because Inflation helps producers realize better margins. This incites them to do better and produce more. No because it reduces the buying power of the consumer in real terms. Last years Price level

MAN MACROECONOMIC STABLZATON POLICY TARGETS REAL GDP GROWTH: Keeping real GDP growth steady helps keep our balance of trade with the rest of the world steady and enables us to consume what we have produced and avoid a buildup of international dept interest. INFLATION: Keeping inflation steady also helps keep the value of the dollar abroad steady. Other things being equal, if the inflation rate goes up by 1percantage point, the dollar loses 1 percent of its value against the currencies of other countries. Large and unpredictable fluctuations in the foreign exchange rate make international trade and international borrowing and lending less profitable and the limit the gains from international specialization and exchange. Keeping inflation low and predictable helps avoid such fluctuations in the exchange rate and enables international transactions to be under taken at minimum risk and on the desired scale. What is IMF? The IMF is an international organization of 183 member countries, established to promote international monetary cooperation, exchange stability, and orderly exchange arrangements; to foster economic growth and high levels of employment; and to provide temporary financial assistance to countries to help ease balance of payments adjustment. The origins of IMF The IMF was conceived in July 1944 at a United Nations conference held at Britton Woods New Hampshire, U.S.A when representatives of 45 governments agreed on framework for economic cooperation designed to avoid a repetition of the disastrous economic policies that had contributed to the great depreciation of the 1930s. And IMF came into existence in December 1945, when the first 29 countries signed its Articles of Agreement. At the same time as the IMF was created, the International Bank For Reconstruction and Development more commonly known as the World Bank, was set up to promote long-term economic development, including through the financing of infrastructure projects, such as road building and improving water supply. IMF Stabilization Programs When the IMF was founded in 1944, it was assumed on Keynesianism. Conditions in the countries borrowing from the IMF were unusual weak: fiscal and external imbalances were large, output was often falling, and inflation was high. Concerned above all the avoid inflation, budget deficits and trade deficits, government kept interests rate high, spending low and exports out. These circumstances posed considerable challenges on the Fundamentals of the IMF adjustment programmers and the IMFs programs dependent on the supply-side policies instead of Keynesianism. The purposes of these programs are to secure immediate improvements in external finances as part of the process of establishing conditions for greater efficiency, saving, investment and growth, over the long-term. Nevertheless, these policies drastically reduced economic activity. After that the new crew (Stiglitz) of IMF economists with one prescription for all problems: privatize, stabilize and liberalize. It includes these policies: Removing restrictions on foreign investments in local industry Cutting tariffs, quotas and other restrictions Devaluing the local currency for making exports more competitive Privatizing state enterprises Reducing wages or wage increases to make exports more competitive Undertaking a deregulation program to free export Reorienting the economy toward exports Stabilization Programs for Turkey Experiences show that motivated stabilization programs were successful because they created major discontinuities in the terns of main macroeconomic variables. Inflation can be lowered quite easily with income policy, but to keep it down requires fiscal restraint, both in terms of increasing tax revenues as well as cutting expenditures. Turkey and the IMF negotiated stabilization programs many times because of our crises. The goals of the programs were to reduce inflation, to ensure sustainable fiscal position and to raise the sustainable level of growth. Considering that all the previous IMF agreements failed to lead Turkey to sustained economic growth and crises went on. The IMF required Turkey to reduce its fiscal deficit (the result of financing a bloated state sector through high interest deficit spending) by increasing taxes. The higher taxation slowed the economy, leading the IMF purpose devaluing the lira to simulate export for economic growth. Turkey complied with IMF loan conditions to reduce its fiscal deficit, began privatizing state corporations and utilities, and established a crawling peg to reduce inflation. Assured of a predictable exchange rate under the peg, the banking sector had taken advantage of easy profit opportunities by borrowing foreign currency at low interest rates in order to buy government debt at much higher interest rates. (This typical reaction to the peg was also a factor in the Mexican and Asian financial crises.) And when the peg collapsed, the already weak banking system was felt with a drastically increased foreign currency debt. And countries (as Turkey) which practiced peg, were exposed by inflation because of weak banking system. That is to say government could not practice monetary policies against inflation.

ENVER AKBA 2001471003 INFLATION AND IMF STABILIZATION PROGRAMME IN TURKEY INFLATION Iflaton is an increase in the general level of prces. TYPES OF INFLATION Demand-Pull Inflation Demand-pull nflaton occurs when average prices rise because aggregate demand grows excessively relative to aggregate supply.When the demand increases the prices are rising.Economists are nearly unanimous in believig that inflation occurs when our demands for goods grow faster than our capacity to produce them. Cost-Push Inflation When a significantproportion of markets experience restrictions on supply, we say that there is costpush pressure.The resulting inflation is cost-push inflation. In cost-push inflation prices rise because of increaese in supply or leftward shifts in supply. INFLATION RATE To calculate the rate of inflation, we use a price index that measures the aggregate price level relative to a chosen base year.The inflation rase is computed as the percentage rate of change in the price index over a given period.There are different prise indexes for different bundles of goods. The Producers Price Index (PPI) This is an index or ratio of a composite of prices of a number of important raw materials, such as steel, relative to a composite of the prices of those raw materials in a base year.It does not correctly measure actual inflation, but it does give an early indication of which way inflation will likely head since many of the prices that make it up are the prices used as inputs in the production of other goods. GDP Deflator The total output deflator or GDP deflatoris an index of the price level of aggregate outputor the average price of the components in total output or GDP relative to a base year.It is the inflation index economists generally favor because it includes the widest number of goods.Unfortunately, since it is difficult to compute, it is published only quarterly and with a fairly substantial lag. Consumer Price Index (CPI) The CPI measures the retail prices of a fixed market basket of several thousand goods and services purchased by households.Each of the goods and services is given a weight in the index in proportion to its importance in the market basket. Inflation rate (t) = CPI (t) CPI (t-1) x 100 CPI (t-1) THE COSTS OF INFLATION Money loses its value People lose confidence in money as the value of savings is reduced. This is particularly the case with rapid inflation. Inflation can get out of control Price increases lead to higher wage demands as people try to maintain their living standards. Businesses then increase prices to maintain profits and so it goes on. Consumers and businesses on fixed income lose out They lose out because the real value of their incomes falls. Employees in poor bargaining positions lose out People in low paid jobs with little or no trade union protection. Inflation favours borrowers at the expense of savers This is because inflation erodes the real value of existing debts. Also the rate of interest on loans may not cover the rate of inflation.

It disrupts business planning Although businesses are aware of what has happened to prices in the past, they cannot be certain what ill happen in the next few months and years. Budgeting becomes difficult and this may affect investment. IMF STABILIZATION PROGRAMMES IN TURKEY What is IMF? The IMF is an international organization of 183 member countries, established to promote international monetary cooperation, exchange stability, and orderly exchange arrangement; to foster economic growth and high levels of employment; and to provide temporary financial assistance to countries to help ease balance of payments adjustment. STAND-BY AGREEMENT WITH IMF IN TURKEY As the Staff Monitoring Agreement signed with the IMF is about to turn to a Stand-by Agreement over a three year program Turkey has gripped the chance to complete a disinflationary program successfully. During this disinflationary period which might be claimed to be continuing since the beginning of 1998 it is a must to reorientate various policies and to lay the foundations of the framework which will be adopted in the end of the following 3 years. Since monetary policy is a vital part of this policy bunch in the new era to come it is important for the Central Bank to devise a frame to detect the outcomes of its policies. In this perspective constructing a core inflation definition is essential.