| In recent years, the Russian central bank has been up against a difficult task. Export revenue growth and capital inflows have added to the build-up of liquidity in the Russian economy. This has been reflected in a pick-up in inflationary pressures, although, for example, labour productivity has also simultaneously improved and the velocity of circulation of money has declined in response to economic policy gaining a higher degree of credibility. Since the turn of the Millennium, the Russian central bank has been moving towards a monetary policy regime that incorporates inflation targeting concurrently with ceilings for appreciation of the rouble's real exchange rate. On top of this, a reference value for monetary growth has been set, which is deemed to be consistent with inflation and expected changes in velocity. Inflation targeting has normally been defined by means of a target band set for year-end consumer price increases. The targeted inflation figure for 2007, for instance, is a year-on-year increase of 6.5%–8% in consumer prices in December. (Currently, it appears that the target band will be overshot in December.) This year, the rouble's real effective exchange rate is allowed to appreciate by a maximum of 10%, and by August it had strengthened by slightly more than 4%. In principle, these two objectives of the central bank may also be in conflict with each other. If, for example, the nominal exchange rate of the rouble had been allowed to appreciate by slightly more this year, inflation would probably be lower. But the central bank places great emphasis on the external competitiveness of Russian companies, thus preferring not to allow an overly strong appreciation of the rouble's nominal exchange rate. |
| The Bank of Finland Institute for Economies in Transition (BOFIT) has analysed Russian inflation and exchange rate problems in a number of studies. Iikka Korhonen and Aaron Mehrotra (BOFIT DP 14/07, Money demand in post-crisis Russia: De-dollarisation and re-monetisation) estimate money demand functions for Russia following the 1998 crisis. The study finds a stable money demand relationship when augmented by a deterministic trend signifying falling velocity in Russia. As predicted by theory, higher income boosts demand for real rouble balances and the income elasticity of money is close to unity. Inflation affects the adjustment towards equilibrium. The results indicate that Russian monetary authorities have been correct in using the money stock as an information variable for monetary policy formulation. It should be noted, however, that the velocity of circulation of money has continued to decline in Russia during this decade. In the future, this change in velocity is set to be smaller than in the past, which may hamper inflation forecasting. The impact of the exchange rate on money demand is also likely to continue despite de-dollarisation of the Russian economy. |
| Looking ahead, the Russian central bank will probably pursue a policy where inflation and exchange rate take centre stage, even if the long-term objective is to change over to mere inflation targeting. Money supply also plays an important role as an indicator variable, but the constantly changing and evolving banking system may constrain its use in forecasting, for example, as has been the case in a number of other countries. |