Decision time for the Russian central bank: To cut or not to

We will soon be launching our new monthly publication Global Monetary Conditions Monitor (GMCM), which will be available from our new ‘research shop’ when we soon launch Markets & Money Advisory’s new website.

GMCM will be covering 25-30 countries and overall we will differentiate between what we term the Global Monetary Superpowers (Fed, PBoC, ECB, Bank of Japan, Bank of England and SNB) and other central banks.

At the core of the publication will be a composite indicator for monetary conditions in each of the countries in the Monitor.

The indicator is constructed as an weighted average of four sub-indicators – broad money supply growth, nominal GDP growth, exchange rate developments and the key policy rate. Each of these four indicators are compared to what we call a policy-consistent growth rate or level for each indicator.

Russian money supply growth nearly on track

If we for example look at broad money supply (M2) growth for Russia (which has a monetary policy decision today) we find the policy consistent growth rate for M2 based on the equation of exchange.

We can write the equation of exchange in growth terms like this:

(1) m + v = p + y

Where m is broad money supply growth, v is the growth rate of money-velocity, p is inflation (GDP deflator) and y is real GDP growth.

We can now insert the inflation target for Russia (4%) as well as the trend growth in real GDP (y*) and the trend money-velocity growth (v*) and by re-arranging (1) we get a policy consistent growth rate for M2 (m-target):

(2) m-target =  4% + y* – v*

We find y* and v* by applying a so-called HP-filter to real GDP and money-velocity.

The graph below shows the historical development in M2 growth and the policy consistent growth rate for M2 (based on an assumption of an 4% inflation target).

Skærmbillede 2017-02-03 kl. 08.37.57.png

It should of course be noted that historically the Russian inflation target has been higher than 4% and there Russian central bank has only in recent years introduced an implicit inflation target.

However, we can nonetheless compare the present actual M2 growth with and the policy consistent growth rate and construct what we call a M2 growth gap.

The M2 growth gap is a three-year weighted average of the difference between actual M2 growth and the policy consistent growth rate for M2. If the M2 growth gap is positive then M2 growth is too fast to ensure that the 4% inflation target will be hit in the medium-term (2-3 years).

We use the M2 growth gap as the one of the four sub-indicators in our composite indicator for monetary conditions.

The three other sub-indicators are also mostly “on track”

Similarly we calculate gaps and sub-indicators for nominal GDP growth, exchange rate growth and the level of the key policy rate.

Overall we use the same logic as when calculating the M2 growth gap when we are calculating the three other sub-indicators.

For example when we calculate the policy consistent growth rate for the exchange rate we find the rate of appreciate or depreciation of the nominal effective ruble rate, which will ensure 4% inflation in the medium-term given the underlying trend in the real effective exchange rate (reflecting for example productive and terms-of-trade trends) and given the trend in foreign prices.

Hence, we essentially in the same way as we used the equation of exchange to calculate the M2 growth gap we for the exchange rate use the Purchasing Power Parity (corrected for trends in the real effective exchange rate) to calculate the exchange rate growth gap and hence the sub-indicator for the ruble rate.

The graph below graph below shows exchange rate gap.


The graph shows that over the past 6-9 months the ruble has appreciated faster than the policy consistent appreciation (actually depreciation) rate and as a result we have seen a negative exchange rate gap develop indicating the development in the forex markets is contributing to a tightening of Russian monetary conditions.

In terms of the overall composite indicator for Russian monetary conditions the too fast board money growth is more or less offset by the too fast appreciation of the ruble, while nominal GDP and the key policy rate are close to policy consistent levels as shown below.

Russian monetary conditions nearly on track

Based on these four sub-indicators we construct our composite indictor for Russian monetary conditions as seen in the graph below.

Skærmbillede 2017-02-03 kl. 09.08.01.png

We see that the indicator remains slightly above zero, which indicates that inflation risks still remains slightly on the upside compared to the Russian central bank’s (CBR) 4% inflation target for 2017. That said, overall monetary conditions in Russia should be considered broadly neutral and overall our indicator lead us to expect Russian inflation between 4% and 5% in the coming 1-3 years (disregarding possible supply side shocks).

As a consequence, it is not surprising that some analysts expect the CBR to cut its key policy interest rate later today or announce intervention in the FX market to curb the appreciation of the ruble.

We would think that would be slightly premature to ease monetary conditions as inflation risks still are slightly to the upside compared to the 4% inflation target, but a minor rate cut of 25 or 50bp should certainly not be seen as irresponsible particularly given the continued appreciation trend in the ruble. Furthermore, we should stress that the purpose of our monetary conditions indicator is not to forecast monetary policy decision, but rather to evaluate whether monetary policy is on track or to easy or tight given the central bank’s inflation target.

If you think that our composite indicator for monetary conditions could be of interest to you as a financial markets partipant or as a policy makers don’t hesitate to contact us regarding more information about how to subscribe to Global Monetary Condition Monitor (GMCM). A 12 month subscription for GMCM will be priced at EUR 2,000. For more information please email or






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