Advocators of a “wait-and-see” approach in the face of supply shocks are not clear on the question of when the supply shock ends and when demand-driven price increases take its place, in an environment where inflation keeps rising. If this issue is not clarified, any above-target inflation figure or any upward revision in inflation forecasts can easily be attributed to supply-side factors. Clear lines should be drawn as to which economic data would refute this discourse and what would constitute a limit to supply shocks from a central banker’s point of view. Dear Guests, In the last part of my speech, I would like to discuss recent developments in the Turkish economy and the monetary policy implemented in this period. In early 2008 the supply side shocks in food and energy prices started to exert significant inflationary pressures, as they reached unprecedented levels above and beyond expectations. For instance, October 2007 Inflation Report, based on forecasts of international agencies, had foreseen oil prices around USD 70 per barrel in 2008 and a gradual correction in food prices. In other words, it was assumed that supply side shocks would be temporary and that they would lose impact after a while. These forecasts were in line with pricing in  BIS Review 109/2008  3  forward and futures markets. However, these expectations did not materialize. Both crude oil prices and agricultural commodity prices continued to rise. The adverse impacts of supply shocks reached unprecedented levels during the first half of 2008.
In other words, we are facing a gap between food demand and food supply. Prices have to adjust to restore equilibrium. Since the price elasticity of food demand is low as compared to,  2  BIS Review 109/2008  say, durable goods, there needs to be a drastic rise in food prices, which is what we are facing today. Dear Guests, Until recently, the common view among central banks of developed countries was to give priority to problems in financial markets, ignoring the signs of inflationary pressures. Certainly, there are structural reasons behind the recent run-up in food and energy prices, as I have just briefly discussed. However, it is also undeniable that there are significant demand-driven pressures over commodities. Loose monetary policies adopted at the turn of the century certainly played a key role, together with excess liquidity in the financial system. Fast-forwarding to the recent period, the central banks of developed countries still keep real interest rates negative in the face of financial risks may hamper a correction in commodity prices. The commonly accepted practice in inflation targeting regime is that monetary policy should not react to supply-driven shocks that are temporary in nature and should allow temporary increases in inflation in the short-term, unless they create deterioration in inflation expectations. Otherwise, undesired fluctuations might arise in economic activity and relative prices. The increase in commodity prices would trigger a self-correcting mechanism. By changing the relative prices, it would provide valuable information on how the resources of the economy should be distributed.