High interest rates and a slowdown in the velocity of money are hampering economic growth

The Ministry of Treasury and Finance, with the support of the Turkish Statistical Institute’s (TurkStat) extraordinary efforts, has finally, after 57 months, managed to bring inflation – which has long been driving up poverty and propelling Turkey towards the global ‘championship’ of food inflation – below 30 per cent. As we know, in the battle against inflation—which simply would not come down—the economic authorities, clinging to “high interest rates” not seen for many years in an attempt to maintain control over the money supply, have nevertheless failed to secure that control. Yet it is well known that as the money supply in the market increases unchecked, inflation soars, and this “money spiral” has been the undoing of many economic administrations. The dream of many economic administrations, however, is to possess the ‘sought-after money’.

Take, for example, the second half of the 12th century; commercial life was spreading rapidly throughout Europe and new trade routes were opening up; for the first time, city-states were forming ‘alliances’ to secure a greater share of this vibrant commercial activity. However, commercial life was developing so rapidly that the money in circulation was not sufficient to meet demand. Coins minted almost everywhere in Europe were used everywhere; yet, they were still insufficient.

In short, the second half of the 12th century was a period characterised by a full-blown money shortage. Up until then, coins had been minted and put into circulation in city-states or kingdoms, and these coins had been in use for years. To alleviate the ‘shortage of money’ caused by the rapid development of trade, the English sterling was minted towards the end of the 12th century.

However, the introduction of the sterling proved insufficient. Consequently, there was a return to the ‘gold coin’, which had been abandoned centuries earlier. The first gold coin of the period was minted in Genoa in 1252. In the same year, ‘gold florins’ were minted and put into circulation in Florence. As this too proved insufficient, the gold ‘Venetian ducat’ was minted in 1264.

Two years later, in 1266, St Louis’s ‘gold ecu’ was also introduced. In the same year that the gold ecu was minted, the French also introduced the silver ‘gros tournois’. Yet the market’s demand for ‘money’ still could not be met. It was as if the coins were simply piling up in the hands of those who held them. Naturally, as always, the market once again ‘fended for itself’ and found its own solution. By now, barter trade at fairs and unorganised trading posts had become increasingly widespread. However, barter was a technique that could be considered far too primitive for a commercial life that was becoming increasingly complex. Consequently, a system of ‘credit notes’—similar to today’s cheques or credit cards—began to be used for transactions.

The development of commercial life, outpacing every form of economic regulation and instrument by leaps and bounds, reached what economists deemed an inevitable conclusion: a crisis.

The economic crisis that erupted in Flanders in 1280 gradually engulfed the whole of Europe throughout the 14th and 15th centuries, and the ensuing years of poverty and epidemics claimed thousands of lives.

In short, during these years when money was scarce, even if money reached a certain velocity of circulation, it failed to reach levels sufficient to sustain the economy; consequently, it threw all stages of the economy—particularly trade—into disarray, thereby paving the way for serious economic crises. To put it another way, since the first ‘state-guaranteed standard coins’ in history—issued in Lydia, one of the most advanced city-states of Western Anatolia in the 7th century BC—became the main driving force of the economy, they have, supported by numerous factors such as ‘production, quantity, velocity of circulation…’ —it has not only opened the door to periods of great prosperity but has also led to crises causing massive destruction, and even major wars, paving the way for the collapse of many civilisations. Underlying all of this are numerous ‘critical factors’, ranging from the ownership of money to its value and, of course, the effects created by its velocity of circulation.

According to economists, a decline in the velocity of money in a country signifies a reduction in the frequency with which money changes hands within a given time period, and a preference for people to hold on to cash or deposits for longer (an increase in the demand for money). One of the main reasons for this is that when the interest rates offered by alternative financial assets, such as bonds, bills and term deposits, are low, the cost of holding onto money (the opportunity cost) decreases. Furthermore, as remaining liquid or spending money immediately is not particularly appealing, money circulates more slowly in the market.

Furthermore, during periods when society tends to prioritise saving over consumption (for example, when households are trying to pay off debts or are concerned about the future), the money earned is not immediately converted into goods and services; instead, it remains in bank accounts or under the mattress. Underlying this is ‘economic uncertainty and insecurity’. Particularly during periods such as economic crises, fears of unemployment, war or political instability, consumers cut back on their spending. Consequently, individuals and some small-scale businesses prefer to hold on to cash or similar safe assets for the purposes of ‘saving’ or ‘caution’, which in turn slows down the flow of spending.

More importantly, a decline in the velocity of money indicates that the wheels of the economy are turning more slowly and exerts a direct downward (contractionary) pressure on inflation and national income; in short, it slows economic growth. This is because a slower circulation of money means that spending and investment are postponed. As companies’ sales fall, production declines and economic growth loses momentum, triggering ‘recession and unemployment’; because a fall in production leads to factories reducing capacity and cutting jobs. This, in turn, can lead to an economic recession that further drags down national income.

In summary: no matter how much money a central bank injects into the market, if people do not spend it but hold onto it (if the velocity of circulation is low), that money neither causes inflation nor fosters economic growth; the economy drifts into stagnation.

The money supply data from the Central Bank of the Republic of Turkey (TCMB) confirms that the velocity of money has fallen. The velocity of money (V) is calculated by dividing nominal GDP by the money supply (M) (V = GDP/M). There are three main reasons why the current situation is causing the velocity of circulation to fall:

Firstly, money remains idle in term deposits; this is because the main drivers of the monthly increases in the M3 money supply are term TL deposits and money market funds. The high policy interest rate (in the 37–40 per cent band) is encouraging households and companies to ‘lock up’ their money in high-yield term accounts (M2/M3) rather than spending it in the market (i.e. keeping it within M1). As money sitting in banks does not change hands, the velocity of money falls mathematically.

However, from an economic perspective, what is even more significant is the effect of ‘credit tightening and a slowdown in commercial activity’. CBRT data clearly shows that the growth rate of household credit has slowed; this is because, despite new liquidity being injected into the market via the credit channel, this money is not being rapidly converted into consumption due to high borrowing costs. Consequently, as the volume of transactions and trade in the market decreases, the frequency with which the same banknote changes hands also decreases.

The loss of momentum in M1—the narrowest and most liquid definition of money—indicates that economic actors are keeping their daily expenditure to a minimum and are rapidly channelling liquid funds into financial instruments that yield a return. This is the single greatest factor blocking the speed at which money circulates in the real economy.

According to CBRT data, a marked slowdown in growth rates and changes in the composition of liquidity have been observed recently across the various money supply definitions (M1, M2, M3). This situation is directly linked to the decline in the frequency with which money changes hands (the velocity of circulation) in the market.

Based on the CBRT’s latest monetary developments and analytical balance sheet reports, M1 stands at 11.4 trillion TL. The annual growth rate has been hovering around 39 per cent in recent times. Periodic monthly contractions in M1 or slowdowns in its growth rate are being observed, particularly due to the unwinding of demand-deposit foreign currency accounts and a decline in demand for cash. M2 (Intermediate Money Supply – M1 + Term Deposits): has reached the 29.4 trillion TL mark. M3 (Broadest Money Supply – M2 + repos, money market funds, etc.): stands at 32.5 trillion TL; however, the annual growth rate has fallen to 32.3 per cent.

Consequently, it is clear that there is a need to gain a little more momentum in ‘economic growth’ – which is, in fact, Turkey’s greatest requirement – in order not to fall behind in developments such as those in the global economy and new technological breakthroughs, as well as in the face of increasingly intense and fierce competition. However, despite all these requirements, the Turkish economy grew by 0.3 per cent in the first quarter of 2026 – following an upward revision – and by 1.1 per cent in the second quarter; consequently, Turkey’s GDP growth rate remained at an average of 1.16 per cent from 1995 to 2026.

Such developments inevitably cast a shadow over forecasts for the Turkish economy’s growth in the coming periods. For example, as we noted in our previous article, the World Bank has revised down its growth forecast for Turkey in 2026 from 3.7 per cent to 2.8 per cent, citing tight monetary policies, falling real wages and rising energy costs. The International Monetary Fund (IMF), noting that the Turkish economy has stabilised in line with the slowdown in domestic demand and tightening measures, lowered its 2026 growth forecast from 3.4 per cent to 2.9 per cent.

The Organisation for Economic Co-operation and Development (OECD) also revised downwards its 2026 growth forecast for Turkey in its global economic outlook reports, bringing it down from 3.1 per cent to 2.7 per cent. Furthermore, the European Bank for Reconstruction and Development (EBRD) has lowered its 2026 growth forecast for Turkey from 3.5 per cent to 3.0 per cent, citing high inflation and tight financial conditions as factors suppressing domestic demand. The credit rating agency Fitch Ratings has also lowered its growth forecast for Turkey in 2026 from 3.6 per cent to 2.8 per cent, due to the impact of tight monetary policies that are constraining domestic demand.

Viewed in this light, the Turkish Statistical Institute (TÜİK) has persisted in refusing to publish the average price list of items in the inflation basket since April 2022, despite court rulings and finalised decisions by the Council of State and the Court of Appeal; 57 months later, last September, to 29.73 per cent—falling below the 30 per cent mark—whilst the Independent Inflation Research Group (ENAG), formed by a coalition of economic experts, calculated inflation at 46.61 per cent in the same month—is simultaneously exerting as much pressure as possible on the ‘economic growth’ that Turkey so desperately needs.

First and foremost, the view that ‘the enemy of inflation is not high interest rates, but a lack of production’ aligns strongly with structuralist economic approaches and supply-side economic theories; according to this view, the primary cause of inflation is the failure of the supply of goods and services (production) in the market to meet current demand.

If there is insufficient production in a country, goods become scarce and prices rise; consequently, this situation creates supply-side inflation or cost-push inflation. High interest rates increase the costs of investment and production. Firms cannot borrow to open new factories or expand their production capacity. This, in turn, can entrench underproduction, thereby fuelling inflation even further in the long term.Therefore, the way to permanently reduce inflation is not to raise interest rates; it is to increase the supply of goods by boosting production, productivity, technological investment and structural reforms. In particular, in economies where even intermediate goods and technological products must be imported for production—and where, consequently, the root causes of inflation lie in external dependence, high raw material costs and insufficient domestic production—simply raising interest rates not only further undermines production but also drags the economy into stagnation (stagflation). Consequently, in economies where structural problems remain unresolved, the path to a lasting solution lies in boosting production capacity.Consequently, to ensure sustainable growth in an economy, to stimulate production, to resolve structural problems and to reduce high inflation, the solution is not to ‘cling to interest rates’, but rather to urgently implement structural reforms that prioritise increasing production to foster competitive production capacity and sustainable growth. By taking all these steps and fostering an economy where production is supported, the velocity of money will also rise as much as possible; it will not lag behind even ox-drawn carts, as is the case today.In short: the main enemy of high inflation is not high interest rates, but high production.