Russian roulette

Is the Bank of Russia stoking inflation?

When the leaders of Russia’s central bank met last week, they had to choose between their monetarist principles and the Kremlin.  The outcome was never in doubt.

The bank’s ostensible duty is to contain inflation, which may peak at 20% this year.  This would mean printing fewer rubles, which are feeding high prices.   But contracting the money supply would also curtail spending.  That would destroy jobs and deepen a recession that already may shrink the economy as much as 4% to 7% this year.  So the Kremlin prefers more rubles to fewer.  And the Bank of Russia, under Elvira Nabiullina, is playing along by cutting interest rates – this time by 1% on the key rate, to 14%; last January, by 2%. 

Like most large central banks, Russia’s governs the money supply by tweaking the interest rate on securities – in Moscow’s case, on “repo” loans that mature within a week.  When the bank buys more repos, it forces up their price, which means a fall in the return that they pay to their holder.  That return is an interest rate.  By buying a lot of securities, the central bank can force interest rates to fall throughout the economy. 

The Bank of Russia also affects the money supply directly:  When it buys the security, it pays out rubles.

The Bank says that won't create inflation since this is due not to abundant money but to weakening of the ruble, which raises domestic prices for foreign products, and to "external trade restrictions."  These factors will disappear by the end of the year, it claims.       

Certainly, money growth in 2014 did not cause much concurrent inflation.  M2 -- "broad money," which includes cash and most monetary accounts except for credit -- rose only 2.2%, while consumer prices rose 11.4%, according to the Bank of Russia.  For 2010 through 2013, the correlation between M2 growth and inflation in the same year was only .53.  And as long as the Russian economy remains below capacity, inflation is unlikely to soar.  Sellers won't raise prices when they're losing their shirts.  

Nevertheless, money may fuel inflation, although it may may take more than a year to show up.  Over the long run, Russia has had both high inflation and rapid money growth.  For 2010-13, inflation averaged 6.8%; M2 growth, 20%.  When the Russian economy is running again at full speed, sellers won't be shy to raise prices -- and buyers, flush with rubles, won't be shy to pay them.

Incredible

Even if the Bank manages to mop up the excess rubles in time, it may not be able to repair the damage done by easy money to its credibility as an inflation fighter.  When the economy begins surging, sellers may doubt that the Bank will curtail impending inflation.  So they will raise prices immediately, since inflation will raise their input costs and erode the purchasing power of their earnings.  Similarly, households may buy goods right away rather than wait for prices to get out of hand.  So even if the Bank can tighten the money supply, the rate of spending (the jargon is "velocity") may rise, pressuring prices to rise.  
     

Easy money may soften the recession, but it probably won’t address the real problem.  The Kremlin seems to think that the recession is driven by a fall in demand for Russian products.  Were this true, prices as well as output would fall.  In reality, both unemployment and prices are climbing -- the classic symptoms of stagflation.  This is usually due to a decline in supply:  When input costs increase, firms produce less than before at given prices for their goods and services.  This will eventually drive up those prices.

The most obvious cause of the stagflation is the Western sanction against Russia.  This has cut off some foreign inputs to Russia -- and raised the domestic price of others, via a 40%-plus plunge in the ruble since last summer.  To end the recession, the Kremlin could come to terms with the US and Europe over its intervention in Ukraine.  Fat chance.  So the best that the Russian people can hope for is some relief from unemployment, bought at the expense of accelerated inflation.  Twenty percent?  You ain’t seen nothing yet. –Leon Taylor tayloralmaty@gmail.com

Notes 

Data on Russian consumer inflation and M2 money come from the Bank of Russia and from the World Bank.  Curiously, the Bank of Russia does not provide English translations for recent inflation statistics, although it does post them in Russian.   

References

Howard Amos.  Political pressure fears as Russia’s central bank set to cut rates.  Moscow Times.  March 13, 2015.

Bank of Russia.  Interest rates on the Bank of Russia operations.  Accessed March 15, 2015. Online. 

Bank of Russia Press Service.  On Bank of Russia key rate.  March 13, 2015.  Online.

Bank of Russia.  Inflatsiia na potrebitel'skom rynke Dekabr' 2014 god.  [Inflation in consumer markets, December 2014.]  Accessed March 15, 2015.  Online.

Olga Tanas and Anna Andrianova.  Russia lowers key rate to 14% as inflation eases amid slump.  Bloomberg.  March 13, 2015.  Online.

World Bank.  World Development Indicators.  Online.