The Gaidar Forum-2019: Sergei Drobyshevsky Has Presented the Study: “The Advantages and Costs of Inflation Targeting in Russia”

On January 17, within the framework of the Gaidar Forum – 2019, Sergei Drobyshevsky, Academic Director of the Gaidar Institute delivered the report: “The Advantages and Costs of Inflation Targeting in Russia” at the  expert discussion: “Inflation Targeting in Russia: Sustainability Test”.

Presenting the findings of the research carried out by a team of experts of the Gaidar Institute and the RANEPA,  Sergei Drobyshevsky stressed that the regime of inflation targeting (hereinafter IT) was currently applied in 36 countries, including 25 developing states.  The challenges for such countries are foreign exchange risks which led to higher flexibility of IT that permits monetary authorities to participate in formation of the foreign exchange rate, as well as abandon IT and switch over to the exchange rate targeting as it happened in the Czech Republic in 2013 and Switzerland in 2015. 

In most developing countries, flexible IT is applied and in decision-making regarding the level of the interest rate it permits to take into account other goals, including a spread issue. Flexible IT makes it feasible to maintain one’s own participation in the formation of the foreign exchange rate by carrying out foreign exchange interventions, REPO operations in foreign currency and currency swap transactions.  In a number of inflation-targeting countries, including those which maintain a free floating exchange rate, there are “reserve” funds which absorb a portion of budget revenues.  

As regards Russia, the Central Bank officially switched over to IT late in 2014, having  set the goal of 4% to be achieved by the end of 2017 (in 2014  the rate of inflation was equal to 11.4%). It is to be remembered that goals regarding the rate of inflation used to be set before, but were never fulfilled in reality. В 2014, the Central Bank raised the key interest rate from 5.5%  to 9.5% and 17%  in March and November, respectively. Prior to a change of the monetary policy regime, the Central Bank of Russia took a number of preparatory measures, including the expansion of the exchange rate band with a subsequent abolishment thereof and narrowed the interest rate band; the key interest rate became the main liquidity management instrument. The role of a REPO transaction with a term of one week largely increased.

Russia’s switchover to the IT regime took place in stressed conditions because the price of oil fell from $110 a barrel to $50 a barrel, Russian companies came under sanctions and their access to the global capital market was limited.  With raising the rate, the Central Bank of Russia sought to prevent further depreciation of the national currency.  A switchover to inflation targeting was accompanied by recession, inflation rate growth and a two-fold depreciation.
The authors of the report are confident that the recession was not exclusively caused by the Central Bank’s policy because external negative shocks were very strong and they were the main factor behind the recession. Sergei Drobyshevsky stressed that Russia had managed to escape the stagflation and devaluation spiral. As a result, in 2016-2017 the inflation rate kept falling and the goal of 4% was attained in H2 2017. Growth recovery began in 2016 with relatively high rates being in place, while CPI growth rates were gradually going down with the key rate following them.  

Speaking about the costs and advantageous of the disinflation in Russia, experts noted that the disinflationary policy would normally lead to recession in the short-term prospect. It is justified by the Central Bank’s interest rate increase which eventually results in GDP drop.  Investment–oriented industries, small- and mid-sized businesses and exporters are hit the worst in this situation. The Russian investment-oriented sector (the building industry and the car industry) plunges into recession and its financial performance gets worse. Also, recession is observed in trade. As regards small and mid-sized business, indicators are inconsistent: a decrease in the number of the employed is registered with the overdue debt being reduced and the premium for the risk of lending to small- and mid-sized businesses remaining unchanged.

According to Sergei Drobyshevsky, positive effects from inflation targeting become evident in the long-term prospect. A drop in inflationary expectations is followed by a decrease in loan interest rates.  Price stability facilitates promotion of the planning horizon of economic agents. Mortgage loan rates kept falling in the past few years, while the terms of lending were growing.

The research in question included a model-based assessment of correlation between public welfare losses and the rate of inflation with use of a partial equilibrium approach. The authors of the report found out that with other factors being equal a decrease in the rate of inflation from 15% to the target level of 4% led to a 1.7% reduction of losses of real GDP; a decrease from 9% to the target level made it feasible to reduce inflation rate related losses by 0.8% of real GDP, while a decrease from 6% to 4% reduced public welfare losses by 0.3% of real GDP.  The target value of 4% permits to ensure flexibility of the monetary policy in case of its easing in future and reduces the risk of deflation across individual groups of goods. However, the speaker pointed out that the inflation rate was allegedly the only source of consumers’ welfare losses.

Speaking about the prospects of inflation targeting in Russia, researchers claim that at present there are no conditions for a switchover from a tough policy to a neutral one as with a target value of 4% the neutral level of the nominal key rate is equal to 6%-7%, while the inflation rate is somewhat above the target value and expectations are rather high. Researchers believe that priorities should include stabilization of expectations and promotion of the reputation of a responsible regulator. It is necessary to upgrade communications with the market because stabilization of inflationary expectations at the level of 4% will lead to a reduction of the entire spectrum of rates.  

“It is possible to speak about success of inflation targeting in Russia only after completion of the phase of economic and political cycles”, the expert of the Gaidar Institute noted. “If the Central Bank remains committed to the declared course after a change of its leader, it will consolidate its reputation and stabilize inflationary expectations. Also, the Central Bank has to go through the “growth-recession” cycle and keep the inflation rate in check. After that, the Central Bank of Russia will finally become an independent, inflation targeting regulator.” 

One can get familiar here with the presentation to the report by Sergei Drobyshevsky.

One can see here the full text of the scientific report: “The Advantages and Costs of Inflation Targeting In Russia.”

Alexander Morozov, Director of the Research and Forecasting Department of the Central Bank of Russia brought the case for the inflation targeting regime on the basis of foreign experience that showed substantial reduction of the rate of inflation. Developed countries benefit more from this regime because their economic growth (sustainable growth) is higher on the back of introduction of the IT regime. Comparison of the two crises – one in 2008 and the other in 2015–2016 – indirectly points to the fact that Russia would have been in a much more unfortunate situation if the IT regime was not introduced.

Natalia Orlova, Chief Economist and Head of the Center for Macroeconomic Analysis, Alfa-Bank agrees with the Position of the Central Bank and says that the Russian economy has a small credit leverage, so, the price of a switchover to inflation targeting is higher in the economy which is more debt-loaded.

Consequently, the conclusion regarding small costs of the switchover to the IT regime is relevant. “It is quite another story why economic growth remains low. In this context, one should pay more attention to structural issues. Economy has found itself in a kind of a growth trap.”  

“In terms of assessment of inflation targeting, I was mainly concerned about the extent to which the Central Bank was in control of market expectations in 2018. This combination of high costs related to rehabilitation of banks and reduction of interest rates in H1 was not quite successful. It gave rise to excessive positive expectations. Change in the Central Bank’s rhetoric and an interest rate increase   took place quite fast”, a participant in the debates said.

Pavel Trunin, Moderator of the Discussion, Head of the Center for Macroeconomics and Finance, the Gaidar Institute and Leading Expert of the Center for Macroeconomic Studies, the RANEPA noted that management of inflationary expectations was the Central Bank’s key task in inflation targeting.

Alexander Isakov, Chief Economist of the VTB Capital, Russia and the CIS pointed to the fact that “the main problem consisted not in anchoring of expectations, including survey expectations, but in anchoring interest rate expectations which were highly volatile.  This issue needs to be discussed further.”
Evsey Gurvich, Head of the Economic Expert Group, Head of the Center for Budget Analysis and Forecasting of the Financial Research Institute (FRI) of the Ministry of Finance of the Russian Federation said that the achievements of the IT regime were evident. Oleg Solntsev, Head of the Center for Analysis of the Monetary Policy and the Banking Sector, Center for Macroeconomic Analysis and Short-Term Forecasting agreed with that.

One can see video recording of the debates here.