Turkey’s Inflation Shift: How Sticky Services Prices Undermine Currency Stability

Turkey’s inflation problem has shifted from goods to services, with services prices proving far more persistent and less responsive to exchange rate stabilisation and monetary tightening than goods prices. IMF researchers find that breaking this services inflation inertia will require structural and credibility-enhancing policies beyond a stable currency and high interest rates.

Researchers at the International Monetary Fund (IMF) have zeroed in on a critical shift in Turkey’s inflation dynamics that helps explain why prices remain stubbornly high despite tighter monetary policy and a more stable currency. In a recent IMF working paper, economists Tara Iyer, Agustin Roitman, and James Walsh argue that the country’s inflation problem is no longer driven mainly by goods prices or exchange rate swings, but increasingly by services inflation, which has proven far more persistent and harder to control.

From Currency Shock to Price Surge

Turkey’s inflation surge began in late 2021, when the lira depreciated sharply following a major policy shift. Inflation, which had been below 20 percent, rocketed to 85 percent year-on-year by late 2022. This initial spike followed a familiar pattern. As an economy heavily reliant on imports priced in foreign currency, Turkey has long seen goods prices react quickly to exchange rate movements. As the lira weakened, import costs rose, pushing up prices for food, fuel, and manufactured goods.

When the authorities later moved to stabilise the currency, first through intervention and then through a dramatic tightening cycle starting in mid-2023, goods inflation responded. Policy rates were raised from 8.5 percent to 50 percent within a year, the lira steadied, and goods inflation began to ease. Many expected headline inflation to follow. It did not.

Services Take Over as the Main Driver

Instead, inflation in services kept rising. By 2024, services had overtaken goods as the largest contributor to overall inflation, even though they make up less than 40 percent of the consumer price basket. Just three years earlier, services accounted for under 30 percent of inflation. This reversal marked a fundamental change in Turkey’s inflation structure.

The increase in services inflation was not limited to one sector. Rents surged as price caps and rigid contracts delayed adjustments and then released pent-up pressure once controls were eased. Hospitality, transport, education, health, and housing-related energy services also recorded strong price increases. Notably, this happened even though some services were subsidised or subject to administered pricing. According to the IMF researchers, services inflation would likely have been even higher without these controls.

Why Services Inflation Is So Sticky

A key reason services inflation has been so hard to bring down is inertia. Service prices tend to adjust slowly and are often influenced by past inflation rather than current conditions. Contracts, indexation practices, and wage-setting rules all play a role. Once service prices rise, they tend to stay high.

The IMF paper shows that inflation persistence in Turkey increased sharply after the 2018 currency crisis and jumped again following the 2021 depreciation. While persistence has eased slightly since mid-2023, it remains high, especially for services, where it now exceeds that of goods. This is unusual for Turkey and stands out even compared with other emerging markets, many of which experienced post-pandemic services inflation but not to the same extent.

What the Exchange Rate Can, and Cannot, Do

Using a detailed economic model, the researchers estimate how exchange rate changes feed into prices. The results are striking. A 10 percentage point depreciation of the lira raises goods inflation by about 5 percentage points at its peak, but services inflation by only about 1 percentage point. Over six months, roughly 45 percent of exchange rate depreciation passes through to goods prices, compared with only about 20 percent for services.

This means that stabilising the currency is effective at slowing goods inflation, but much less powerful when it comes to services. Goods prices react quickly and then cool. Service prices react less to the exchange rate, but once they rise, they remain elevated. This asymmetry explains why Turkey has seen falling goods inflation alongside stubbornly high services inflation, and why headline inflation has stayed higher than expected.

The Policy Lesson Going Forward

The IMF paper places Turkey’s experience in a broader international context, drawing lessons from past disinflation episodes in countries such as Brazil, Argentina, and Israel. The message is clear: when inflation becomes embedded in services, monetary tightening and exchange rate stability alone are not enough. Successful disinflations usually require additional measures to break inflation inertia, such as reducing backward-looking indexation, reforming contracts, and strengthening policy credibility.

For Turkey, this means that while tight monetary policy and a stable lira are essential foundations, they are unlikely to deliver lasting price stability on their own. Without addressing the structural features that keep service prices rising, inflation may remain a problem even if the currency holds steady. As the IMF researchers make clear, Turkey’s inflation challenge has evolved, and policy will need to evolve with it