Accumulated analysis of inflation targeting discussed at the Gaidar Forum
The 10th anniversary Gaidar Forum hosted a discussion on monetary policy in Russia. The experts discussed the benefits and costs of Russia's transition to inflation targeting.
Sergey Drobyshevsky, Director for Research, the Gaidar Institute for Economic Policy presented the report "The benefits and costs of inflation targeting in Russia." He stressed that the regime currently applies in 36 countries, including 25 developing countries. Such countries are challenged by exchange rate risks, which have led to increased flexibility of inflation targeting that allows monetary authorities to participate in the exchange rate setting process, and to the rejection of inflation targeting and the transition to exchange rate targeting, as it happened in the Czech Republic in 2013 and in Switzerland in 2015.
Most developing countries use flexible inflation targeting, which makes it possible to take other goals, including those on the output gap, into account when deciding on the level of interest rates. Flexible inflation targeting allows to retain participation in the exchange rate setting process through currency interventions, repo operations in foreign currency, making currency swap transactions. In a number of countries that target inflation, including those that adhere to a freely floating exchange rate, there are “reserve” funds that absorb part of budget revenues.
As for Russia, the Central Bank officially switched to inflation targeting in the end of 2014, announcing a target of 4% to be reached by the end of 2017 (in 2014 inflation was 11.4%). It is necessary to understand that before this the inflation targets were also set, but they were not achieved in practice. In 2014, the Central Bank raised the key rate from 5.5% in March to 9.5% in November and to 17% in December. Before the change in the monetary policy regime, the Bank of Russia implemented a number of preparatory measures, including expanding the currency corridor, and then eliminating it, narrowing the interest rate corridor, and the key interest rate became the main instrument for managing liquidity. The role of the weekly repo transaction has also grown.
Russia's transition to inflation targeting occurred under stressful conditions, as the price of oil fell from $110 to $50 per barrel, sanctions were imposed on Russian companies, and access to the global capital market was restricted. Raising the rate, the Central Bank also tried to prevent a further devaluation of the currency. The transition to the inflationary regime was accompanied by recession, inflation growth, and a double devaluation.
The authors of the report are convinced that the recession was caused not solely by the policy of the Central Bank of the Russian Federation, since external negative shocks were very strong, and they are the main cause of the recession. Sergey Drobyshevsky notes that it was possible to prevent slipping into stagflation and the devaluation spiral. As a result, inflation declined in 2016–2017, and the 4% target was achieved in the second half of 2017. Growth recovery began in 2016 at relatively high rates, and CPI growth rates consistently declined, followed by the key rate.
Noting the costs and benefits of disinflation in Russia, the authors of the report recalled that disinflation policy usually leads to recession in the short term. This is justified by the increase in rates by the Central Bank, which leads to a decline in GDP. The main damage is inflicted onto the investment industries, small and medium-szied businesses, and exporters. In Russia, in the investment-oriented sector (we are talking about the construction, automobile industry), we see a decline and deterioration in financial performance. In addition, a decline in trade was noted. For small and medium-sized businesses, the indicators are contradictory, since a decrease in the number of people employed was recorded with concurrent reduction in overdue debts and a constant risk premium for loans to small and medium-sized businesses.
Sergey Drobyshevsky emphasizes that the positive effects of inflation targeting are manifested in the long term. A decrease in inflation expectations is followed by a decrease in lending rates. Price stability contributes to the lengthening of the planning horizon of economic agents. Mortgage rates have declined in recent years, and lending terms have increased.
As part of the study, a model assessment of the relationship between social welfare losses and inflation through a partial equilibrium approach was carried out. The authors of the report found that, ceteris paribus, a decrease in inflation from 15% to a target level of 4% leads to a decrease in losses by 1.7% of real GDP; from 9% to target, it reduces inflation-inflicted losses by 0.8% of real GDP; and from 6 to 4%, it reduces welfare losses by 0.3% of real GDP. The target value of 4% keeps the monetary policy flexible and allowing mitigation in the future, it acts as a factor in reducing the likelihood of deflation for certain groups of goods. At the same time, Drobyshevsky notes that, presumably, inflation is the only source of consumer welfare losses.
Speaking about the prospects of inflation targeting in Russia, the authors of the report argue that currently the conditions for the transition from strict to neutral policy have not been formed, since with a goal of 4% the neutral level of the nominal key rate is 6-7%, and inflation itself is somewhat higher that the goal, and the expectations are quite high. Researchers consider it a priority to consolidate expectations, acquire the reputation of a responsible regulator. It is necessary to improve communication with the market, since the stabilization of inflation expectations at the level of 4% will lead to a decrease in the entire range of rates.
“It is possible to talk about the success of inflation targeting in Russia after passing through the phase of economic and political cycles,” says Sergey Drobyshevsky. “If the Central Bank is able to maintain its commitment to the declared policy after the change of its manager, this will strengthen its reputation and secure inflation expectations. Also, the Central Bank must go through a "growth/recession" cycle and keep inflation under control. After that, the Central Bank of the Russian Federation will finally take shape as an independent regulator that targets inflation.”
Alexander Morozov, Director of the Research and Forecasting Department of the Central Bank of the Russian Federation, gave the arguments based on the experience of foreign countries in favor of the fact that the introduction of an inflation targeting (IT) regime leads to a greater decrease in inflation. Developed countries benefit more from such a regime, since their economic growth (its steady growth) is higher against the background of the IT regime introduction. A comparison of the two crises – 2008 and 2015–2016 – indirectly indicates that Russia would have been in much worse situation if the IT regime had not been introduced.
Natalia Orlova, chief economist, head of the Alfa-Bank's Center for Macroeconomic Analysis, agreed with the position of the Central Bank and noted that the Russian economy has a small leverage, so the price of switching to inflation targeting should be higher in an economy that is more leveraged. Therefore, the conclusion that the transition costs are not very large is adequate. “Another thing is that, while continuing to argue about why economic growth remains low, we should look more at structural problems. The economy itself is now in some growth trap.”
“My main concern and problem in terms of IT assessment is related to the extent to which the Central Bank controlled the market expectations in 2018. This combination of high costs for the reorganization of banks and lower interest rates in the first half of the year is not a very successful combination,” the discussion participant noted.“This gave rise to excessively positive expectations. The change in the rhetoric of the Central Bank and the increase in the interest rate was very fast.”
Moderator of the discussion, Pavel Trunin, a leading research fellow at the Center for Macroeconomic Research, RANEPA, noted that managing inflation expectations is one of the key roles of the Central Bank in inflation targeting.
Alexander Isakov, the chief economist at VTB Capital in Russia and the CIS, emphasized that “our main problem is not in the area of expectations anchoring, including expectations based on polls, but in anchoring of expectations for the interest rate that are quite volatile for us. This problem needs more discussions.”
Evsey Gurvich, Head of the Economic Expert Group, Head of the Center for Budget Analysis and Forecasting at the Research Institute of Physics and Engineering of the Ministry of Finance of the Russian Federation, noted that the achievements of inflation targeting are undeniable. Oleg Solntsev, Head of the Division for Analysis of Monetary Policy and Banking Sector at the Center for Macroeconomic Analysis and Short-Term Forecasting, agreed with him.
10th Gaidar Forum Organizers:
The Russian Presidential Academy of National Economy and Public Administration (RANEPA);
The Gaidar Institute for Economic Policy (Gaidar Institute);
The Association of Innovative Regions of Russia (AIRR).
The general partners of the Gaidar Forum are Gazprom and Gazprombank; strategic partners include Prosveshcheniye publishing house, Coca-Cola, Pharmstandard group, ACIG Group of Companies, the Russian Textbook Corporation, SANOFI, Novartis, Johnson & Johnson, Russian Railways, MSD, and Mastercard; EY, Cisco and Russian Direct Investment Fund are partners. This discussion’s partners are Philips, Cherkizovo and RVC.
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