In 2021, the Bank of Russia changed the key rate seven times. And over the past eight years, the Central Bank of the Russian Federation has done this 39 times. None of the financial regulators in developed countries has adjusted the rate so often over the years.
In theory, raising the key rate should have stopped inflation long ago, which obviously got out of control of the authorities last year. The Central Bank predicted it at 4%, but even «officially» prices rose by 8.4% over the year. And now the always optimistic Ministry of Economic Development cautiously expects inflation to reach 5.9% in 2022. But the Central Bank looks to the future much more confidently — its forecast remained the same — 4%. But how to keep prices within these limits? And does it depend on the Central Bank?
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Dry theory speaks
Why is the key rate important in terms of managing price increases? Economic theory suggests that by changing the key rate, the Central Bank can control the behavior of financial institutions, much like a traffic police inspector controls the speed of traffic.
In theory it should work like this. Businesses have two sources of money: you can sell goods, or you can take out a loan. Formally speaking, «money» is «credit» — these are two different names for the same thing — assets and liabilities of the banking sector. The issuance of a loan to one person (or company) means exactly the same (modulo, but opposite in sign) increase in the monetary savings of another person (or company). The ruble borrowed for expenses by the buyer Petrov will turn into a ruble of income on the account of the seller Petrov. The only risk that matters is that the debtor Petrov will not be able to pay off his debt obligations. And by raising the rate, the «Central Bank warns»: be careful, the risks of default can be high.
A loan can be expensive and cheap — if the loan rate is high, then it is more profitable to sell goods, if the rate is low — it is more profitable to take loans.
And what about inflation? By raising the rate, the Central Bank, as it were, says to manufacturers — look, do not raise prices! Buyers won't have the money to pay for your products, and it will be difficult for them to get credit. Consumers in a situation of a high key rate also behave differently than in a situation when it is reduced. Cheap credit means that it is more profitable to turn money into goods than to keep it in bank accounts. People go to stores and buy, and manufacturers see an increase in demand for their products and raise prices, that's inflation. But when the rate rises, consumers begin to think that it is better to save money. Demand for goods is declining, and manufacturers, if they do not reduce prices, then stop raising them.
No one is perfect
In an ideal economy, it works like this. But humans are not perfect, economists will say. For example, they may simply not understand what behavior the financial authorities expect from them. The study Human Frictions in the Transmission of Economic Policies, conducted by an international group of scientists, showed that the level of intelligence of people affects their ability to perceive the signals that bankers send to the economy. After analyzing data on consumer behavior and credit history and comparing them with the results of intelligence tests, the researchers found that the higher the level of a person's IQ, the better people understand what is happening in the economy and the more actively they adjust their economic behavior in connection with these changes. In general, the smarter people are, the better they respond to economic incentives. At the same time, neither the credit burden nor the level of income affects the quality of economic decisions.
Moreover, the availability of cheap money could be the flip side of low unemployment, the economists would add. Yes, rising prices are unpleasant, but the lack of work is even worse. However, in terms of unemployment in Russia, there has not been such a good situation for a long time, at least formally. According to the Central Bank of the Russian Federation in the report “Regional Economy: Comments of the Main Departments” No. 10, “…in 2021, the demand for labor increased markedly in the context of a recovery in economic activity and continued restrictions on labor mobility. In November, the number of vacancies in the employment service amounted to 2.1 million applications, which is 19% more than a year earlier and 32% more than in November 2019. According to the HeadHunter portal, the number of posted vacancies in December 2021 increased by 50% y/y, or almost doubled compared to the same period in 2019. Under these conditions, unemployment, according to the Bank of Russia, was close to the historic low of 4.3% in November.”
You can also recall that the economist Ulrika Malmendir from the University of California in the study The Making of Hawks and Doves: Inflation Experiences on the FOMC proved that the decisions of the leaders of the financial regulator regarding the cost of credit are not determined by current considerations about the relevance of a particular economic policy, but personal experience. Malmendir and her co-authors analyzed 7,350 voting results of members of the US Federal Open Market Committee (FOMC) from 659 meetings of the Committee from March 1951 to January 2014, as well as data on each of the participants in the meetings.
Scientists have found that Fed directors who grew up during a period of rising prices in the American economy more often insisted on fighting inflation and advocated a high key rate. And those who did not face inflation, but saw unemployment, advocated «cheap money» and economic growth at any cost.
The price of distrust
By the way, the same rule applies to ordinary people who are not allowed to take decisions of the Central Bank. The already mentioned Ulrika Malmendir in her work Exposure, Experience, and Expertise: Why Personal Histories Matter in Economics explained that the experience of financial trauma affects people for decades.
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This applies not only to Russians who survived the dramatic inflation of the «nineties», and the financial crisis of 2008, and economic stagnation along with falling incomes over the past eight years. And you can’t blame people for distrusting the policy of the financial authorities, as the study by Sergey Guriev and Maxim Ananiev showed Effect of Income on Trust: Evidence from the 2009 Economic Crisis in Russia,
during the 2008 crisis amid falling incomes there was also a drop in the level of interpersonal trust — from 34% in mid-2008 to 19% in 2009. Poverty divides:
Economists' data showed that a 10% drop in income is associated with a five percentage point drop in the proportion of citizens who believe most people can be trusted. And the worst thing is that the restoration of confidence is lagging behind the growth of the economy. It turns out a vicious circle: if you want to restore your income, you need to increase economic activity, but for this you need to trust both your neighbors and the actions of the government, and people do not believe because they are painfully experiencing their crisis experience. And the simplest mechanism to reduce risks in a situation of mistrust and uncertainty is to stock up on goods, at any price, or money — by selling your goods at any price. Or by selling your labor — if you can do it. The high prices set by Russian entrepreneurs include a “percentage” of their distrust of each other.
Systemic reasons
Scientists from the Institute of Economic Forecasting of the Russian Academy of Sciences pay attention to the situation with the availability of credit for the economy. In the report “Quarterly Forecast of the Economy. Issue No. 53,” academic economists comment on the situation with the Central Bank’s key rate.
“Under the current conditions, the end of the key rate increase is unlikely to become an important driver for the growth of investment in fixed assets. Despite the fact that the Russian economy has actually been living in conditions of near-zero rates in real terms for two years already (adjusted for inflation. — Ed.), this did not become a factor in a radical increase in the dynamics of loan lending for the bulk of non-financial enterprises. At the same time, stopping the growth of the key rate will at least make monetary policy neutral with respect to economic dynamics.”
In general, experts from the Russian Academy of Sciences say that the key rate should not be increased, but reduced. Then there will be investments. And since there will be investments, it means that there will be an expansion of production. And the expansion of production will mean an increase in the supply of goods, that is, increased competition and … lower prices.
But something tells me that this won't work. If the real rate has been “near zero” for two years already, and “non-financial enterprises” do not borrow or invest in fixed capital, then the issue here is not the rate. And in unacceptable business risks.
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By the way, as experts from the HSE Center for Business Research write in their analytical review of business trends in the service sector that emerged in the fourth quarter of 2021, “first of all, one can single out a noticeable increase (from 55 to 60%) in the number of respondents who noted the problem of high economic uncertainty . “Uncertainty of the economic situation” confidently tops the rating of factors limiting the activity of service sector organizations…”. But such a factor as “a high percentage of commercial credit” occupies the penultimate place in the list of “limiting factors”. And in last place is “corruption in government”, which worries only 4% of respondents.
The conclusion here is this —
The problems of the Russian economy are not caused by the monetary policy of the Central Bank, not by the quarantine crisis, not by unemployment (which is declining) and not even by oil prices (with them, then everything is in order).
There are more systemic and serious reasons.
Fiscal miracles
These reasons can be judged by reading Commentary on the State and Business No. 409 of the HSE Development Center, entitled «Fiscal Miracle».
The «miracle» was such — according to the preliminary data of the Ministry of Finance, for 2021 revenues of the federal budget amounted to 25.3 trillion rubles, exceeding the planned figures by 35% (!).
Five factors of “extraordinary growth” of budget revenues are identified at the Higher School of Economics:
- significantly higher than planned economic growth rates
- growth in world oil prices (planned $45.3/bbl, while in 2021 Urals averaged $69.1/bbl .)
- noticeable reduction in household savings rate compared to 2020
- decrease in international mobility due to the coronavirus pandemic
- acceleration of inflation to 8.4% (December to December)
As a result, instead of the planned deficit of 2.75 trillion rubles. the budget was executed with a surplus of 0.5 trillion rubles. In 2021, federal budget revenues increased markedly both in absolute terms and in relation to GDP, economists write.