Recent discussion among Russian policymakers of the strategy paper ‘Basic Principles and Objectives of Monetary Policy for the years 2015 and 2016/17’ threw up some interesting facts relating to our economic life. It became clear that the dividing line between market liberals and supporters of active state intervention in the economy, which has existed for many years, has considerably shifted. It used to be that the industrialists within the government were for active state support while the finance and economy bloc was against; now the government is almost united over questions concerning economic expansion. It would appear that the only body against this is the Finance Ministry, which can sometimes be overruled by collective efforts. This is, however, no simple matter because the Finance Ministry enjoys the support of the Central Bank of Russia.
At a meeting of the government to discuss monetary policy, the Chairman of the Central Bank (CBR) Elvira Nabiullina, spoke against a reduction in the CBR key rate (currently 8% in October 2014), with the aim of stimulating the economy. She maintained that in the current economic climate this instrument would do the economy no good at all, and the negative consequences could be very serious.
Current economic climate
What did she mean by the current economic climate? Firstly, that recovery growth has come to an end, and there is no, or almost no available excess manufacturing or labour market capacity, meaning that in the near future, increased productivity is not a possibility.
Secondly, the lack of clarity during the last two years as to future developments in the Russian, or world economy, together with the considerable political risks which have arisen this year, are holding back investment activity. Investors prefer to accumulate profits rather than ploughing them into new projects, which means that large-scale creation of new, or renewal of existing manufacturing capacity and jobs is not happening. With no increase in production, jobs or services in the near future, the Russian economy will stagnate. This reluctance to invest stems not only from an unwillingness to part with capital in stagnation conditions, but from other reasons, as well. It could be to build up reserves so as to be able to meet imminent credit payments, extremely relevant in today's conditions. Or it could be to pay shareholders a dividend. Or a third reason could be the wish to keep profits in liquid form, and thus ready for various speculative operations should the need arise i.e to be in a position to take a punt on price increases for one or other asset.
With no increase in production, jobs or services in the near future, the Russian economy will stagnate.
The Central Bank Chairman spoke of the negative consequences of stimulating economic growth: businessmen are unwilling to invest so the additional credit they would be able to obtain from the banks (as a result of the liberal monetary policy) will be used for speculation. This leads to price increases and a fall in the value of the rouble, and is to be avoided at all costs by keeping the interest rate high, making access to refinancing by the Central Bank more difficult for commercial banks.
Conversely, operating an expansionist policy will result not only in stagnation, but in stagflation i.e. a combination of a decline in industrial output and consumer demand, and growing inflation.
Russian GDP since the fall of the Soviet Union. Photo CC: LokiiT
Stagnation is neither supernatural nor an anomaly – it has occurred many times in the world economy and will continue to do so. There is nothing frightening about it, especially as the current stagnation in Russia is occurring in conditions of full manufacturing and labour market capacity, suggesting that the particular conditions of the Russian economy (demographic decline) make it easier for us to bear than for other local economies. Thus, at first glance the Russian government has little cause for alarm and no need to introduce any additional measures to deal with it.
But there is stagnation and stagnation. It is one thing when production and revenues stand still for many years in countries of the 'golden billion' (industrially developed nations) and quite another when it happens in Africa or some Latin American countries. For the first group, many years of 'stable revenues' may pose no particular threat, whereas for the second group this stability means poverty, which could well become starvation. For this reason, local economies in the first group can tolerate stagnation for a long time, but economies in the second group must be constantly expanding whatever the worldwide economic situation.
But there is stagnation and stagnation.
At this point, China provides a very good example: a complex demographic means that there is a strong incentive for the economic authorities to stimulate economic growth, especially in conditions of a world depression. Come what may, China must keep up high growth rates or there will be a threat of events developing there as they did in Egypt two years ago.
But the Russian Federation does not fit into either of these groups: there may not be poverty or destitution on a mass scale (according to strict UN criteria), yet this does not make life any easier. Many people in Russia, especially pensioners, subsist on very small means and their only chance of somehow increasing these means lies in high rates of economic growth. On top of this the Russian government wants to play an active part in world politics, which also costs big money. So overall, the conditions obtaining in Russia are pushing economic leaders willy-nilly towards artificial stimulation, of whatever sort, especially when organic growth incentives cease to function.
However, as often happens, the trend towards long-term growth comes up against the barriers of the market. The existence of financial sanctions makes talk of any kind of growth, even if only artificial, completely impossible. Many Russian companies will be compelled to direct all their income to repayment of foreign debt, since they no longer have any chance of refinancing it. But if all (or almost all) their income is used to settle their debts, then companies will be undercapitalised and unable to continue production at previous volumes. This means that, instead of stagnation, which would not be a bad option, we could be in for a significant decline in output.
It is then that the part played by the Central Bank and the Finance Ministry becomes crucial, because only they have the resources (currency reserves) to compensate Russian companies for capital outflows, and to prevent a reduction in output. So, in any discussion of the basic principles and objectives of sound monetary policy, the question of whether (or not) we should use our currency reserves to keep the Russian economy afloat by compensating the outflows of foreign capital is more important than whether we should be using monetary policy to stimulate the economy.
The CBR key rate is only an indicator. If it is lowered, there is some hope that a considerable number of Russian companies will be able to refinance their foreign currency debts; if not, only a few companies will be able to refinance, and the rest will be faced with either defaulting or – if they all decide to repay their debts – a reduction in output. But there is also another completely realistic scenario – speculating on the effects on the rouble exchange rate if there is a rate cut…
This article first appeared in polit.ru on September 30