ECON 2004 – Engineering Economy

Spring 2020
Week 8

Chapter 8
Inflation and Foreign Exchange
 ECON 2004 – Engineering Economy
Chapter 8- Price Changes & FX Rates
Price Changes

Consumer Price Index, CPI is a composite price index that measures average change
in the prices paid for food, shelter, medical care, transportation, apparel, and other
selected goods and services used by individuals and families.
In Turkey, it is Tüketici Fiyat Endeksi, TÜFE.
Another measure is the Producer Price Index, PPI.
In Turkey, it is Üretici Fiyat Endeksi, ÜFE.
They are calculated monthly by Türkiye İstatistik Kurumu, TÜİK.
TÜİK determines prices of 924 types of goods by surveying 27,886 businesses and
4,281 households at frequencies ranging from daily to monthly.
Increases (decreases) in the monthly indexes
are the monthly inflation (deflation) figures.
 ECON 2004 – Engineering Economy
Chapter 8- Price Changes
Inflation
Annual Inflation is the rate of increase in TÜİK / 2003 = 100
year-end Price Index figures. (or last 12 months)
ÜFE 2014 2015 2016 2017 2018 2019 2020
Quoted and used mostly.
Jan 229.1 236.6 250.7 285.0 319.6 424.9 462.4
Such as salary, rent increases.
Feb 232.3 239.5 250.2 288.6 328.2 425.3 464.6
Annual Average Inflation is the rate of increase
in annual average Price Index figures. Mar 234.0 242.0 251.2 291.6 333.2 432.0 468.7
(or the average of last 12 months) Apr 234.2 245.4 252.5 293.8 341.9 444.9
More stable. May 233.0 248.2 256.2 295.3 354.8 456.7
Jun 233.1 248.8 257.3 295.5 365.6 457.2
Jul 234.8 248.0 257.8 297.7 372.1 452.6
Aug 235.8 250.4 258.0 300.2 396.6 450.0
Sep 237.8 254.3 258.8 300.9 439.8 450.6
Oct 240.0 253.7 260.9 306.0 443.8 451.3
Nov 237.7 250.1 266.2 312.2 432.6 451.0
Dec 235.8 249.3 274.1 316.5 422.9 454.1
avg 234.8 247.2 257.8 298.6 379.2 432.0
Annual
Inflation 2015 2016 2017 2018 2019
Dec-to-Dec 5.7% 9.9% 15.5% 33.6% 7.4%
average 5.3% 4.3% 15.8% 27.0% 13.9%
 ECON 2004 – Engineering Economy
Chapter 8- Price Changes
Real-TL; Purchasing Power of Your Salary

Suppose that your annual salary is 45,000 TL and will increase at 4% per year through year 4.
If the inflation rate ( f ) is expected to average 6% per year,
what is the real-TL equivalent of your 4th year salary?

ATL: Actual TL is the number of TL as of the time it occurs. [ Cari ya da Güncel TL ]

RTL: Real ( or Constant ) TL is expressed in terms of the same purchasing power relative to a particular time,
i.e. base period. [ Reel ya da Sabit TL ]
RTL = ATL / ( 1 + f ) no of years in between
annual year 4
year 1 increase (after 3 increases)
Nominal Salary 45.000 4,0% 50.619
Price of an Apple 1 6,0% 1,19
Salary in Apples 45.000 -1,9% 42.501

Real-TL Salary in year 4 = 42,500 TL of base period, year 1

If you can buy 45,000 apples per year in year 1,
this means that you should expect to be able to buy 42,500 apples per year in year 4.

This is the "Purchasing Power" concept of Real-TL.

1 + real = ( 1 + nominal ) / ( 1 + inflation )
 ECON 2004 – Engineering Economy
Chapter 8- Price Changes
Annual Interest Rates in Turkey

( 1 + nominal ) / ( 1 + inflation ) = 1 + real

1+i nominal
1+i real =
1+ inflation expected

Oct Oct Oct Oct

2017 2018 2019 2020
[ 1-year deposit rate ] nominal interest rate 10% 20% 11,5%
[ D CPI Last 12 Months ] actual inflation 25% 9% ?
real interest -12% 10% ?
 ECON 2004 – Engineering Economy
starting Nominal Chapter 8- Price Changes
date Interest
Nominal Annual Interest Rates in Turkey
2001/2 40.4%
2002/2 56.0% [1 yıllık mevduat
2003/2 44.0% faiz oranı]
2004/2 21.0%
2005/2 16.0%
2006/2 15.0%
2007/2 15.0% interest rate data
2008/2 15.0% www.tcmb.gov.tr
2009/2 12.3% İSTATİSTİKLER
Parasal ve Finansal
2010/2 7.5% İstatistikler
2011/2 6.5% Faiz İstatistikleri
2012/2 6.0% - Kredi Faizleri
2013/2 5.5% - Mevduat Faizleri
2014/2 4.8% - Kredi Kartı Faizleri
2015/2 4.8%
2016/2 9.3%
2017/2 9.3% Two basic types of interest exist; borrowing rate (loans for individuals)and lending rate
2018/2 10.0% (deposits for individuals). For banks, they are vice versa.
2019/2 18.6% Various types, nevertheless, move roughly in parallel.
2020/2 11.0%
 ECON 2004 – Engineering Economy
Chapter 8- Price Changes
Annual Consumer Inflation Rates in Turkey
starting Nominal ending Annual
date Interest date Cons Inf 80%
2001/2 40.4% 2002/2 73.1%
2002/2 56.0% 2003/2 27.0% 70%
2003/2 44.0% 2004/2 14.3%
2004/2 21.0% 2005/2 8.7% 60%

2005/2 16.0% 2006/2 8.2%

50%
2006/2 15.0% 2007/2 10.2%
2007/2 15.0% 2008/2 9.1% 40%
2008/2 15.0% 2009/2 7.7%
2009/2 12.3% 2010/2 10.1% 30%
2010/2 7.5% 2011/2 4.2%
20%
2011/2 6.5% 2012/2 10.4%
2012/2 6.0% 2013/2 7.0% 10%
2013/2 5.5% 2014/2 7.9%
2014/2 4.8% 2015/2 7.6% 0%
2015/2 4.8% 2016/2 4.5% 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 18 19
2016/2 9.3% 2017/2 15.4% Nominal Annual Interest Annual Consumer Inflation
2017/2 9.3% 2018/2 13.7%
2018/2 10.0% 2019/2 29.6%
2019/2 18.6% 2020/2 14.2%
 ECON 2004 – Engineering Economy
Chapter 8- Price Changes
Annual Real Interest Rates in Turkey
Real Interest Rate, ir may be calculated as follows: 1 + inominal = ( 1 + f ) * ( 1 + ireal )
starting Nominal ending Annual Real 30%
date Interest date Cons Inf Int
25%
2001/2 40.4% 2002/2 73.1% -19%
2002/2 56.0% 2003/2 27.0% 23% 20%
2003/2 44.0% 2004/2 14.3% 26% 15%
2004/2 21.0% 2005/2 8.7% 11%
10%
2005/2 16.0% 2006/2 8.2% 7%
2006/2 15.0% 2007/2 10.2% 4% 5%
2007/2 15.0% 2008/2 9.1% 5% 0%
2008/2 15.0% 2009/2 7.7% 7%
-5%
2009/2 12.3% 2010/2 10.1% 2%
2010/2 7.5% 2011/2 4.2% 3% -10%

2011/2 6.5% 2012/2 10.4% -4% -15%

2012/2 6.0% 2013/2 7.0% -1% -20%
2013/2 5.5% 2014/2 7.9% -2%
-25%
2014/2 4.8% 2015/2 7.6% -3% 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 18 19
2015/2 4.8% 2016/2 4.5% 0%
2016/2 9.3% 2017/2 15.4% -5%
2017/2 9.3% 2018/2 13.7% -4% 2001 2008 2014 2001
2018/2 10.0% 2019/2 29.6% -15% 2007 2013 2019 2019
2019/2 18.6% 2020/2 14.2% 4% avg Real Interest 8% 1% -4% 2%
 ECON 2004 – Engineering Economy
Chapter 8- Price Changes & FX Rates
Real Rate of Return in FX

iTL = rate of return in TL

iFX = rate of return in Foreign Exchange [Döviz]

fe = annual devaluation rate between TL and FX

1 + iFX = ( 1 + iTL ) / ( 1 + fe )
i€ i TL f€
2.8% 12.0% 9.0%
 ECON 2004 – Engineering Economy
Chapter 8- FX Rates
How FX Rates are Determined
Law of One Price:
If two countries produce an identical good,
and transportation costs and trade barriers are very low,
the price of the good should be the same throughout the world
no matter which country produces it.

Suppose that American steel costs 100 $ per ton

and identical Japanese steel costs 10,000 ¥ per ton.
For the Law of One Price to hold,
1 $ should be worth 100 ¥.
 ECON 2004 – Engineering Economy
Chapter 8- FX Rates
How FX Rates are Determined
Theory of Purchasing Power Parity (PPP)
states that exchange rates between any two currencies
will adjust to reflect changes in the price levels of the two countries.
The theory of PPP is simply an application of the Law of One Price
to national price levels rather than to individual prices.
Suppose that the Yen price of Japanese steel rises 8% (to 10,800 ¥)
due to inflation in Japan
while the Dollar price of the American steel rises 4% (to 104 $)
due to inflation in the US;
then 1 $ should be worth 103.85 ¥ reflecting the inflation difference.
1+ Japanese Inflation 1+ 8%
-1 = -1 = 3.85% = devaluation of Jap Yen against US$
1+ American Inflation 1+ 4%
 ECON 2004 – Engineering Economy
Chapter 8- FX Rates
$/TL and €/TL Exchange Rates [Döviz Kuru]
$ and € are the two most basic currencies in World trade and the Turkish foreign trade.
 ECON 2004 – Engineering Economy
Chapter 8- FX Rates
Average Annual Devaluation of TL against $ and €
April $/TL €/TL
30%
2002 1.31 1.15
2008 1.27 1.99
2014 2.12 2.91 20%
2020 6.75 7.30

10%
$/TL €/TL
02-08 -1% 10%
08-14 9% 7% 0%
14-20 21% 17%

-10%
02-08 08-14 14-20
$/TL €/TL
 ECON 2004 – Engineering Economy
Chapter 8- FX Rates
Average Annual Devaluation of TL against FX Basket of $ and €
20%
$+€
$/TL €/TL April Basket
1.31 1.15 2002 2.46 15%
1.27 1.99 2008 3.26
2.12 2.91 2014 5.03
6.75 7.30 2020 14.05 10%

$+€
$/TL €/TL Basket 5%
-1% 10% 02-08 5%
9% 7% 08-14 7%
21% 17% 14-20 19% 0%
02-08 08-14 14-20
 ECON 2004 – Engineering Economy
Chapter 8- FX Rates
Avg Ann Deval of TL against $+€ Basket versus Avg Ann Inflation Diff
Inflation TR avg US D
20%
02-08 14% 2.2% 2.7% 1.7%
08-14 8% 1.7% 2.0% 1.4%
14-20 13% 1.3% 1.5% 1.2%
avg 12% 1.7% 2.0% 1.4%

Annual $+€ 10%

Inflation Basket
Diff Deval
02-08 12% 5%
08-14 7% 7%
14-20 12% 19%
avg 10% 10% 0%
02-08 08-14 14-20
Annual Inflation Diff $+€ Basket Deval