After a formal introduction of inflation targeting at the end of , inflation in Russia was put in check. Average inflation in — was 3. This represents a significant disinflation from 8. The inflation expectations of households and businesses decreased significantly, but were still relatively high, and, more importantly, unanchored. In this situation, the Bank of Russia was able to conduct counter-cyclical monetary policy for the first time in modern Russian history.
However, the proper sequencing of policy changes was the main challenge. We had to account for the impact of short-term inflation increases and exchange rate fluctuations on household and business expectations and behaviour. After years of high inflation, Russian households have become used to reacting to significant inflation spikes and exchange rate depreciations by increasing demand for durables and hard currency.
This behaviour became much less pronounced in the recent years, due to a decline in inflation and in its sensitivity to the exchange rate. The effect of fiscal policy on demand and inflation was another factor that we considered in our policy discussion. At the onset of the Covid crisis, at the time of the lockdowns, fiscal measures — in particular, social transfers to households and grants to businesses, and regulatory incentives to restructure loans — proved to be more effective tools to support demand in the Russian economy than monetary policy.
However, accounting for lags in monetary policy transmission, monetary policy easing had to be started as early as possible to support economic recovery at a later stage, after the removal of tight lockdowns and at the time of fiscal policy normalisation. We kept the interest rate unchanged in March, to stabilise inflation expectations at a time of high market volatility.
By the end of April, FX market pressures had subdued. Inflation pressures due to the ruble depreciation and the panic buying of storable consumer goods in March had subdued as well. Our assessment was that the effect on inflation expectations and household behaviour of short-term inflationary pressures was limited.
Therefore, we started a monetary policy easing cycle. Lending rates also decreased significantly following the decline in money market rates and long-term bond yields.
This supported a fast economic recovery in the third quarter of By the end of the third quarter, inflation pressures appeared. We considered these to be of a short-term nature. Compared to the first round in March, the second round of exchange rate depreciation triggered a more significant pass-through effect on prices against the backdrop of recovering demand.
In addition, prices of some basic food products started to rise as well, largely due to increases in these prices on international markets. Household inflation expectations rose significantly.
At the same time, deposit interest rates reached a record low level. As a result, households started to look for alternative means of savings: structural products, bonds and equities including foreign ones , and investments in housing. Under these circumstances, the Bank of Russia decided to take a pause in the policy easing cycle and wait until inflation expectations stabilised.
However, economic recovery and inflationary pressures proved to be stronger than we originally expected. Therefore, our assessment as of the middle of February was that policy easing was over, and in March we increased the interest rate to 4.
Overall, the important lesson from our experience is as follows. Our earlier efforts to earn policy credibility bore fruit. It was our improved credibility that allowed us to implement monetary policy easing during the Covid crisis. Nonetheless, our policy space was more limited than many observers thought.
Our effective lower bound for the policy rate proved to be much higher than zero because of still-high and unanchored inflation expectations of households and businesses. However, if we arrest inflation, which currently runs above our target again, and keep it close to the target for longer, this may widen our available policy space should another crisis occur.
While inflation targeting is a common monetary policy regime among the major emerging market central banks, their views on FX operations differ substantially. Another group believes that, although FX interventions can be used for financial stability concerns, their use should be limited and well communicated. Otherwise, the active use of such interventions could undermine the effectiveness of inflation targeting by provoking markets into thinking that the central bank tends to target the exchange rate rather than inflation.
The Russian approach is to consider FX operations separately from the monetary policy framework. As an oil-dependent country, Russia has a fiscal rule that, to a large extent, isolates the Russian economy and markets from oil price fluctuations. In addition to this, at times of stress we use targeted exchange rate operations, usually in the form of FX swaps or repos, which provide FX liquidity to the banking sector.
The Bank of Russia also reserves the right to amend the time schedule of FX purchases done in accordance with the fiscal rule if it is needed for financial stability purposes. During the Covid crisis, the main financial stability concern was the destabilising effect of the exceptionally low oil prices that were observed in March and April The fiscal rule helps to stabilise the real exchange rate when oil prices fluctuate. However, it works with a certain lag and it is less efficient at very low oil prices, when non-budgetrelated oil revenues decline significantly.
Oil prices fell abruptly, reaching extremely low levels in March and April Thus, the Bank of Russia had to pre-emptively stop FX purchases and start FX sales in March using the formula that replicated the fiscal rule given the observed levels of oil prices. Our assessment prior to the Covid crisis was that the Russian banking sector had ample FX liquidity. Therefore, in March we decided not to launch additional FX liquidity instruments, such as repos.
However, this instrument was not in demand by banks, in contrast to the previous crises, when FX liquidity had been a problem. This can be explained by the substantial dedollarisation of the Russian economy and the banking sector and a light foreign debt payment schedule. The rapid stabilisation of global liquidity conditions was also a factor. Overall, the key difference between the Bank of Russia FX operations and those of other emerging market central banks during the Covid crisis is that the FX operations in Russia were relatively small and addressed the effects of oil price volatility rather than capital flow volatility.
What can explain the success of the Russian approach? There are several hypotheses. First, the oil price volatility that we target is correlated with capital flows to Russia anyway.
Second, Russian foreign debt is low by international standards, so the size of capital outflows is relatively modest. Finally, regulatory forbearance measures that the Bank of Russia implemented in March prevented an asset fire sale by Russian financial institutions and even prompted them to purchase assets from foreigners at low price levels, thus stabilising the Russian financial markets.
At the time of extreme volatility, the Bank of Russia allowed financial institutions not to mark assets on their balance sheets to market prices, but to use pre-stress fixed asset prices instead.
In March , a regulatory forbearance measure allowed banks and other financial institutions to use the ruble exchange rate and asset prices as of 1 March This decreased the sensitivity of bank balance sheets to market fluctuations and created additional capacity for banks to buy assets at low prices.
In contrast to many other emerging market central banks, the Bank of Russia decided that asset purchases were not justified during the Covid crisis.
Our reasoning was as follows. Inflation targeting in Russia was relatively new, so unconventional policy could have damaged the credibility of our monetary policy. Moreover, the Bank of Russia did not perform asset purchases as regular monetary policy operations.
In our operational procedures, we used repo operations instead. Therefore, asset purchases could have confused the markets, undermining our credibility and provoking suspicion of fiscal dominance. Besides, due to the low level of government debt and cautious monetary policy at the onset of the Covid crisis, the Russian bond yield curve, while moving up, still did not become outrageously steep by historical standards.
Markets functioned smoothly, supported by the regulatory forbearance measures described above. The yield curve went down quickly once the period of extreme volatility ended. Therefore, asset purchases by the Bank of Russia were not justified for financial stability concerns. In Russia, extra Covidrelated government debt issuance was purchased by local banks that were interested in floating-rate bonds for interest rate hedging.
We launched monthly and annual repo auctions with a starting interest rate equal to our policy rate plus 0. While initially the market suspected that these liquidity lines would be used for de-facto central bank financing of government debt, the actual use of these facilities was rather low and narrowly concentrated during the period of a temporary liquidity gap, when the government accumulated significant liquidity on its account at the central bank, not being technically ready to quickly spend it on budget appropriations.
In addition, we decreased the costs of access to uncollateralised liquidity lines from 0. The Bank of Russia considers communication to be an important monetary policy and financial stability tool. As far as monetary policy is concerned, the goal of our communication policy is to subdue market reactions to interest rate announcements and thereby smooth yield curve changes.
Therefore, while making decisions on interest rates, we also signal our views on future policy to the markets. At the same time, we try to avoid an interpretation of our signals as commitments. We believe that such commitments can be counterproductive at a time of high volatility, and may even increase volatility of the yield curve. As far as financial stability is concerned, out main task is to improve market confidence. We modified our communication policy, making it more focused and intense in April and May The Governor of the Bank of Russia held regular weekly press conferences, where she provided our up-to-date assessment of the situation in the economy and in the financial system.
She announced new support policy measures when it was necessary and shared monitoring data on the implementation of earlier measures, including on credit restructuring. The conferences were also accompanied by the publication of a weekly analytical review, The Financial Pulse, which contained all relevant information in a succinct format.
These conferences played an important role in preserving the confidence of the market. To better and more quickly assess the situation in the Russian economy, in addition to statistical data, we started using our new in-house index of financial flows to and from various industries based on real-time payment data.
We have also been using the results of weekly company surveys conducted by our regional offices. This has helped to improve confidence in central bank policies as well as economic trends in general, and has had a positive impact on market stabilisation. During and crises, monetary policy space and policy choices of the Bank of Russia were limited because of high household inflation expectations and the failure of a number of weak banks.
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