A strong policy response – on the back of fiscal buffers, a strong financial system, and favorable external conditions – enabled Turkey to recover from its shock of 2016, with growth accelerating to 7.4 percent in 2017.
Countercyclical fiscal policy and private sector credit boosted demand, and helped overcome labor market and financial sector rigidities to accelerate production. Short-term fiscal and credit measures helped avert a bigger collapse in demand and production after the economy contracted in Q3 2016. They also contributed to progress on poverty reduction.
The balance of risks in the Turkish economy since Q3-Q4 2017 has shifted from growth to stability. Demand has overshot supply capacity and macroeconomic imbalances have widened. The outcome of supply constraints and demand impulse are reflected in high inflation; a large current account deficit; and currency volatility.
Turkey has been prone to large economic swings in the past. The greater the volatility in growth, the more pronounced is the negative impact on productive investment and efficiency of resource allocation. This hurts long term productivity and potential output, both of which have stagnated in Turkey.