Expansionary Monetary Policy in Russia
Russia is currently facing the problem of disinflation and low economic activity due to political instability. So the Russian government’s solution was government intervention, or the government being involved with the workings of the market, where Russia's Central Bank implemented an Expansionary Monetary Policy (EMP) by decreasing interest rates from 9.5% to 7.5%.
Lower interest rates, by lowering the cost of borrowing and the benefit of saving, will encourage people to take loans and increase spendings. This will encourage households and firms to spend and recover economic activity by directly increasing consumer spending and investment in the AD = C + I + G + (X - M) formula, meaning that the AD will increase, shifting the curve outwards. Not only does the AD increase, but also GDP and price levels increase.
The policy implemented by the Central Bank possesses numerous advantages in decreasing the deflationary gap. For example, EMP has a shorter implementation time due to the absence of governmental approval and few decision-makers. Thus, the central bank responds more quickly to the financial crisis. However, the time lag of the effect could take up to 18 months, which is a long period and deflation could become more severe.
Secondly, other sectors of the economy might be positively affected. By increasing AD, local firms can raise prices due to demand-pull inflation, which could lead to profit maximization and economies of scale. This means that firms will have higher profits and will need higher output, meaning they will need a larger workforce, therefore unemployment will decrease, especially cyclical unemployment, which will increase GNI. This will lead to previously unemployed households earning money that might then be spent. As a result, the AD will rise again, starting a cycle that will cause continuously increasing economic activity.
Thirdly, local producers were vastly affected by the recession, especially those who were exporting goods, because their customer range got limited to local consumers. Other producers have also been affected because the purchasing power of local consumers has worsened, and the cost of sustaining the businesses increased due to inflation earlier that year. But with the policy, consumer purchasing power and AD might increase, meaning that producers may revive their revenues and avoid bankruptcy. Moreover, it will also benefit the local consumers because their range of options has also narrowed due to sanctions, and with the local producers getting higher revenues the AS might increase, meaning that the quality of products might increase or price decrease. Additionally, lower cost of borrowing means that new firms might enter the markets and existing ones might invest, thereby increasing competition that generally benefits the consumers.
Fourthly, interest rates can be adjusted incrementally, meaning that the central bank can evaluate the economy and adjust the interest rate, even though the highly fluctuating economy makes it challenging. However, it can create challenges as people know that the interest rate can decrease even more, down to 6.5-7%. Therefore, households might wait longer to get a lower interest rate. Additionally, it will encourage firms to take loans at lower rates, because predictions and signals from the central bank show that by a specific time the interest rate will
be lower. Therefore, firms that tend to plan long-term, will plan their long-term budgets based on the predicted lower interest rates.
On the other hand, the sanctions initially started the recession, leading to fluctuations that led to low consumer and business confidence. This is problematic because it makes consumption and investment interest inelastic, so money is not spent and economic activity is not revived. Moreover, the recession may limit the policy, in terms of households and firms deciding to repay their debts caused by the recession earlier that year. Mainly it relates to low-income families, as they were mainly affected by political instability and forced to go into debt. If the economic activity and GDP do not increase, the policy will contradict its aim.
Moreover, monetary policies are usually dependent on the global economic status, which currently is poor. Also, the policy might lead to currency depreciation. In reality, the theory may not hold true because Russia’s isolation due to sanctions, made the economy immune to the global recession, due to lower dependence on international trade. Moreover, the currency depreciation will have a small effect on exporting, because due to sanctions trading partners have terminated contracts.
Finally, this policy has an alternative that might be more effective- expansionary fiscal policy (EFP), which involves lower tax rates. As taxation decreases, households' disposable incomes and businesses' profits increase, which in turn increases consumer spending and investments. Consequently, economic activity rises and since these are the components of AD, it also increases, leading to economic growth. Furthermore, increasing AD will also increase prices, another issue that is being addressed. However, to fund the policy the government will potentially have to sell bonds to the private sector. This leads to the “crowding out effect”, leaving the private sector with less cash that could be spent or invested, which contradicts the policy. Moreover, there is also a risk of people using lower taxation to repay debts due to the earlier recession.
Overall, government intervention and the policy implemented could be considered effective, because even though it has disadvantages, it focuses on achieving the main aim of decreasing the deflationary gap and reviving economic activity. Nonetheless, the context is vital, as the policy is implemented during a war. Consequently, the central bank will be even more vulnerable to external pressures, especially from the president, who elects the central bank governor and manages the military actions. As a result, fiscal and political policies might pull in different directions, thereby damaging the policy’s effectiveness.
Written By Dinmukhamed Tynybek | Proofread by Yasmin Uzykanova
