Russia Drops the Policy Rate – What Does It Mean?

The ruble has stabilized at near pre-invasion levels, and the Central Bank of Russia drops the policy rate to 17%. What’s going on?


If one only looked at these two variables, one could be excused for thinking Russia had adeptly managed to stabilize the economy. However, these two variable are only two components of exchange market pressure (last discussed in this post), sometimes measured as:

EMP = αΔs – βΔres + γΔi

Where α, β and γ are parameters that are typically the inverse of the variance of the associated variable, and res (foreign exchange reserves normalized by money base) and i might be relative to the core country (typically the US).

What do reserves look like? The Central Bank of Russia was reporting this through until about March 25, when it stopped. Here’s a plot of what we thought Russia had as of that date (about $604.4 billion, shown as red dot in figure below, down $38.8 bn from end-February).

While this doesn’t look like an overwhelming drop, there are two things to remember. First, the $38.8 billion (reported) loss occurs in the space 3-1/2 weeks. Second, because lots of the reserves are held offshore with other central banks and private financial institutions, Russia does not have access to all the remaining $604.4 billion of international reserves.

How can we interpret the Russian action in the context of a Mundell-Fleming model? Back in February 22 (before the extent of the further invasion of Ukraine became apparent), I interpreted sanctions about to be levied thus:

That increase in interest rates (only 9.5% at the time) would push the Russian economy toward recession.  Subsequently, as the ruble collapsed, policy rates were pushed to 20%. Today, the rates have been dropped to 17% (Reuters).

The Russian central bank sharply cut its key rate to 17% on Friday and said future cuts were possible, as emergency steps had contained the risk to financial stability, brought deposits back to banks and helped limit the threat of inflation, it said.

I interpret the situation as follows:

The BP=0 curve has rotated, which allows the Central Bank some latitude to drop rates. So, temporarily, the highly distorted foreign exchange market looks stabilized, as does (as far as we know) reserves. But this is at the cost of imposing very tight capital controls. It’s not clear how much monetary policy will be able to offset the negative impacts of decreased exports, cuts in crucial imports of intermediate inputs necessary for domestic production (i.e., I’ve left out the supply shock that’s impacting prices).

As for inflation, here’s the most recent data (note: month-on-month CPI, not annualized), at 7.6%:

7.6% m/m annualized is 140.8%.