Monetary policy in Russia

Abstract

The Russian economy has known dramatic economic events since the dismantlement of the Soviet Union. Those events have led to periods of very high and volatile inflation rates followed by successive stabilizations. For such an economic environment, the question as to what determined the central bank's stabilisation policy becomes important. The central bank of a matured economy can be expected to use interest rates to regulate the inflation rate. In early Russia, the absence of an effective monetary policy framework was due not only to the challenge of establishing new institutions and regulations, but especially to the difficulty of overcoming the legacy of central planning where budget and credit financing were indistinguishable.22 The role of the Central Bank of Russia (CBR) was not well defined. During certain periods, the CBR acted as the banker of the government providing liquidity without consideration for the financial markets. During other periods, its action focussed on the financial markets to provide a restrictive monetary policy or to provide funds to a weak financial industry. In any of these cases one can expect a disconnection between inflation and interest rates. Post-Communist Russia's monetary policy has passed through two monetary regimes: a money based programme was used from July 1992 to June 1995 and from September 1998 to the present (February 2005)23; an exchange rate based stabilisation programme was used in the period from July 1995 to August 1998. Behind these variations in the policy regime lies a continuum in the tension between price and exchange rate stability. A constant factor can be discerned underlying this tension. This factor is the authorities' use of macroeconomic policy as a direct instrument of social welfare provision. In the period through to the August 1998 crisis, this phenomenon took the form of a lack of fiscal adjustment, in turn generating heavy budget deficit financing requirements. The subsequent period has seen sustained budget surpluses (since 2000) due to fiscal discipline rather than to the strength of the oil price.24 High world oil prices have widened the balance of payments surplus. The monetary authorities have been pulled between the goal of reducing inflation and the goal of restraining the real exchange rate appreciation resulting from the balance of payments surplus in order to shelter domestic employment from import competition. The CBR seems to have preferred slowing the real exchange rate appreciation rather than the inflation rate, as a result inflation proxied by the consumer price index changes has stayed quite high, reaching 11.7 percent in 2004 compared with 12 percent in 2003, exceeding a government target of 8 percent to 10 percent. To remedy the conflict taking place between price stability and currency appreciation, this paper recommends a move to inflation targeting that may give more control over price stability to the central bank while reducing its interventions in the foreign exchange market.25 Other economies in transition such as the Czech Republic, Poland and Hungary have adopted inflation targeting for reasons of joining the EMU.26 Our contribution here is to analyze the dynamics of Russian monetary policy suggesting that adopting inflation targeting could help the CBR to reduce the tension between the exchange rate and the monetary policy. The chapter is organised as follows: In Section 2 we present the state of the monetary and exchange rate policies in Russia, with a model, deriving an optimal interest rate rule in section 3. The data, and the empirical results are presented in Section 4. The search for a possible relation between interest rate, inflation rate, exchange rate and real money growth is expected to indicate what type of policy has been followed by the central bank. Some interesting dynamics are established through impulse responses and variance decompositions within a VAR model. Section 5 concludes the chapter. © Springer Berlin · Heidelberg 2006.