I HAVE SINGLED out two scenarios. They pertain to both global and local dynamics, which are intertwined in the days of COVID. The first encompasses a rapid amelioration of economic conditions due to the positive impact of vaccines. The second is based on a more pessimistic view that claims the outbreak won’t be easily contained and will bear on 2021 in its entirety. Similarly, the domestic side of the first scenario entails a correct equilibrium standing of monetary policy and fiscal policy. As a result, portfolio inflows will be normalized and reserves will accumulate. And, of course, tourism revenues will increase come summer. The second, more pessimistic, scenario would involve – possibly due to the advent of early elections in H2, and an earlier than warranted return to loose monetary policy – excessive budget spending, low interest rates and so on. That would mean an unwarranted U-turn anew. Because the breakout will rage on according to this scenario, a tight monetary stance won’t last beyond summer. This ought to involve even higher inflation, yet another currency shock, and high output and employment cost. The reality can be between the two extremes, obviously. I personally lean on the optimistic scenario by, let’s say, 70%. In that case, what could happen?
Food and transportation-fueled December inflation. At 14.6% CPI and 25.15% DPPI even the ‘official inflation’ is a lot higher than envisioned by midsummer. It became obvious though that CPI was heading toward 15% by October at the latest. The main reason is the currency shock. The second reason is high imports and import prices. Whenever there is a significant pass-through effect or an import price impact, or both, inflation rises fast. On the face of it I expect an even higher annual rate by the end of January. The passthrough runs its course in the span of either four or five months; so the impact of TRY stabilization remains to be seen. We are still under the spell of the impact multiplier of a USD/TRY that spiraled out to 8.50 in July. Again, in January we will observe the immediate impact of tax rate hikes and raises in the administered prices. Also, credit expansion runs its course for up to 9 months – usually two quarters though. That limits any drop in domestic demand. In other words, the extremely loose monetary policy and credit expansion at inordinately low rates of Q2 and Q3 in part continue to bear on current inflation.
Another take-away is the rapid increase in DPPI. Now, both houseware prices and the DPPI betray a high pass-through coefficient, higher than ordinarily estimated to be. This may have come from the new ‘way of life’: people don’t go out much because there is nowhere to go, and they don’t buy clothing, which posted negative inflation. Instead, they buy housing products, consumer durables, electronics, garden tools and whatnot in order to alleviate the psychological pain engendered by a certain kind of social embeddedness. Another observation comes from the diffusion index: inflation is widespread across sub-sectors.
If the first scenario obtains, eventually inflation will fall. Interest rates will be kept tight for a minimum of two quarters, supply disruptions will ease, portfolio investments will endure well into the year, the lira will appreciate and come September things will look almost set for a little loosening. Yet as we see in metal prices, commodities and agricultural prices might well remain high throughout the year. Hence, even assuming the on-going successful monetary course won’t be interrupted, inflation may not fall much. I am not sure whether the ‘scissors’ formed between consumer inflation and producers’ prices would narrow down because the CPI would eventually converge to the DPPI. The converse may also happen. Still, it is a sure bet that low double-digit inflation by the end of 2021, i.e. 11-12%, is what we ought to expect. Disinflation isn’t easy to obtain unless demand collapses and the economy contracts, just as there is no easy way to make dollarization go away or to build credibility within the span of a couple of months.
Even so, there are many other problems, I mean on the inflation front. There is independent research measuring annual inflation at 36%. There is undeniable evidence that food prices are a lot higher than the head-on inflation. Food prices may remain high in 2021 globally. Even at a 21.6% minimum wage increase, it is unclear if the ‘real’ inflation faced by low income workers has been compensated. That brings us to the conundrum of the minimum wage, a problem that has been controversial lately. Yes, the minimum wage has an impact on unemployment, and yes minimum wage increases above head-on inflation would raise production costs, and translate into consumer inflation since that would raise demand at the same time. But then, people can’t live on thin air, no?
DIGRESSION: MINIMUM WAGE AND THE GENERAL WAGE CURVE
Over the last 8 years since Bernanke spoke in May 2013 and there was a turnaround in EMs, the Turkish CPI posted 11.2% compound annually. Food inflation was 13.1% on average. Yet the minimum wage increase CAGR stood at 17.6% between January 2013 and January 2021. Now, isn’t that high if we are to believe the ‘official’ inflation figures? Has there been a corresponding productivity increase? In other words, is the minimum wage low or high or is it ‘just about right’?
There are many studies that show the minimum wage has some kind of impact on the entire wage curve itself, and raises costs, which results in job losses in the formal sector and job openings at below minimum wage rates in the informal sector. Women are especially affected, and so on. I will come back to this burning issue next week with more data. However, the debate is also ideological. It may be good to remember a bit of labor history. What was the minimum wage originally?
In the Anglo-American world, during the second half of the so-called Progressive Era – from 1908 into the 1930s, those calling for reform, or in the jargon of Norman Schofield, “prophets of chaos”, managed to change labor regulations radically. This second wave of statutory reforms regulated working conditions. Child labor was forbidden, working hours were reduced. There were even some attempts at paying pensions to mothers. But the focal point was the institution of a minimum wage.
Now, everyone had agreed that by 1920, a minimum wage would cause job losses. The unemployment that would result, dubbed ‘dis-employment’ a century ago, was regarded as a social benefit by the so-called Progressives who resorted to eugenics to render exclusionary immigration laws acceptable to the public. The prominent neoclassical economists of the era, such as Alfred Marshall, Philip Wicksteed, A.C. Pigou and John Bates Clark were against it. The American Association for Labor Legislation supported it and academic economists played an important role in passing such regulations. In the end, a minimum wage was fixed. The purpose was to exclude the “unemployable”: women, children, immigrants, and “low-races” – Irish, Italians, Hispanics and so on. Even renowned Fabian socialists such as Sidney and Beatrice Webb made it clear that “the resulting unemployment would be a social gain because the “unemployable” wouldn’t be employed at the minimum wage that would be higher than the market rate. The inefficient “others” were seen as ‘parasites’, carriers of ‘social disease’, and enemies of ‘social health’. Those who “unfairly” drag down wages of more deserving workers would be cast out of the labor market since no employer would pay them the minimum wage. The minimum wage was intended to protect deserving workers from the competition of the unfit by making it illegal to work for less. It wasn’t enforced or even demanded by the workers themselves at that particular junction.
Inflation will rise in January and possibly in February, too. The policy rate may stay put in January, but then it may not in February. I think there is a need to raise the policy rate more, but not much. 19% can be equilibrium at some point. Then, we will wait. And yes, inflation is already beyond the tolerable. Yet there are other related, but different, crucial issues as well. Hence there will be more on firm costs, labor costs, productivity and inflation next week. Also there will be more on the radical transformation that has already begun in the job market. Yes, Turkish firms are in that, too. Turkish firms can be quick to adapt, and it seems they do.