Inflation and Monetary Policy in Russia: Transition Experience and Future Recommendations

Abstract

This paper seeks the main factors behind inflation in Russia over the period 1996–2001. It presents a succinct description of Russian monetary policy and inflation developments. The econometric analysis establishes a long-run relationship between demand for the real money balances on the one side and the real income and short-term interest rate on the other side. It also presents several specifications of modeling shortrun dynamics of inflation. An account is made for the change in the exchange rate regime after the financial crisis of August 1998. It finds that apart from strong inertia, money expansion and exchange rate depreciation played a role in fueling the CPI. However, there were significant shifts in the underlying trends driving inflation during the studied period.

Until 1999 fiscal policy posed the biggest obstacle to the disinflation process in Russia. In 2000–2001 the main responsibility for sustained inflation pressure can be attributed to monetary policy trying to target money supply and exchange rate at the same time. The way out from this policy trap leads through the adoption of one of the so-called 'corner' solutions, i.e. either a permanently fixed exchange rate, or independent monetary policy under a free float regime. Taking into consideration a historically limited credibility of macroeconomic policy and the high level of dollarization, the first variant seems to be a better solution for Russia. However, its implementation would require the accompanying fiscal, banking and other structural reforms creating a healthy policy-mix and flexible microeconomic environment.