What’s happening to the Russian economy?
Today modern "patriots" will readily tell you how unfriendly countries are destroying our nation's economic power. Indeed, sanctions pressure is completely destroying national prosperity right away and we can only expect the situation to worsen in the near future.
However, the West's corrupting and pernicious influence began long before Russia invaded Ukraine. The policy that laid the fragile foundations of Russian "stability" was based on the precepts of orthodox economic theory: to some extent, we are all living in a house that American economists built.
This text offers an alternative reading of recent economic history and points to possible ways out. Rejecting the traditional approach, we base our analysis on the ideas of the post-Keynesian school of economics. The "trivial truths" led us into a dead end long before February 2022, now we have to change our frame of reference.
However, the West's corrupting and pernicious influence began long before Russia invaded Ukraine. The policy that laid the fragile foundations of Russian "stability" was based on the precepts of orthodox economic theory: to some extent, we are all living in a house that American economists built.
This text offers an alternative reading of recent economic history and points to possible ways out. Rejecting the traditional approach, we base our analysis on the ideas of the post-Keynesian school of economics. The "trivial truths" led us into a dead end long before February 2022, now we have to change our frame of reference.
We are referring to the basic strategies and principles of economic management, which the Russian government has adhered to. These approaches borrowed from Western economists have led to an obvious loss of Russian influence in the world, which resulted in the Special Military Operation
Previous years
The whole post-Soviet model of economic development, which began to decline at the beginning of the 2010s and finally ceased to exist in February 2022, has put us in today's vulnerable position. To understand the preconditions of the current crisis, it is important to understand what exactly that model consisted of. Without going into a deep historical excursus, we will limit ourselves to two conditional periods: pre-Crimean (2000 - 2014) and post-Crimean (2014 - 2022).
The pre-Crimean period in the Russian economy illustrates well the so-called "low base effect". After the disastrous experience of the 1990s, the beginning of the 2000s Russia resumed to increase its share of global commodity markets again. During the first half of the pre-Crimean period, oil exports doubled to five million barrels per day, returning to 1989 levels. The recovery of volumes slowed in 2008, but oil prices doubled.
Low base effect — Economists use this term when explaining impressive growth rates by low starting points.
The trade liberalization was accompanied by the liberalization of economic policy. The gradual lifting of restrictions on capital flows attracted foreign investors to Russia's financial market and industrial sector. Increasing of oil and gas revenues and foreign investments created the conditions for the steadily high growth rates of the Russian economy. Declining unemployment and growing incomes of the population contributed to the dynamic development of the consumer market. The country actively imported both consumer goods and capital goods, while maintaining a trade surplus.
Along with the economy, the taxable base also grew. With the growth of revenues, the government was able to increase spending, avoiding a budget deficit. In the pre-Crimean period nominal government spending increased by 10 times and 4 times the salaries paid by the public sector. Public sector wages improved the situation in the whole labor market: teachers, doctors and officials supported consumer demand, which allowed businesses to expand. Russia's economy grew according to an almost Keynesian recipe.
Along with the economy, the taxable base also grew. With the growth of revenues, the government was able to increase spending, avoiding a budget deficit. In the pre-Crimean period nominal government spending increased by 10 times and 4 times the salaries paid by the public sector. Public sector wages improved the situation in the whole labor market: teachers, doctors and officials supported consumer demand, which allowed businesses to expand. Russia's economy grew according to an almost Keynesian recipe.
In other words, Russia sold more goods and services than it bought from the outside world, accumulating foreign currency and financial instruments denominated in it.
Keynesianism — is a line or school of economic thought, its proponents point to insufficient consumer demand as a major obstacle to economic stability. If the economy is not operating at maximum employment and resource utilization, growing demand leads to an expansion of output, which creates demand for means of production and new jobs. The new jobs, in turn, expand consumer demand again, and so on. In the face of stagnation, Keynesians advocate expanding government spending and other ways to increase aggregate demand.
However, fiscal policy remained prudent. The experience of the transition to a market economy demonstrated the dangers of radical solutions. Explosive price rises, devaluations, and the accompanying social tensions were fresh in the collective memory. Even during the commodity boom, the state prioritized fiscal discipline and kept a close eye on stable but stubbornly high inflation rate. Stability became the main priority of economic policy.
An economic policy related to budget expenditures and tax collection
The content of the idea of "stability" was changing markedly over time
It was planned to stabilize the economy by reducing the dependence between the economic dynamics of Russia and world oil prices. In periods of high commodity prices, state expenditures grew along with oil and gas revenues of the treasury, supporting economic growth. When oil prices fell, state revenues suffered as well. In such years, the principle of budget balancing required spending cuts, despite the accompanying economic instability. In the absence of other growth factors, the Russian economy looked more and more like the tail of the global oil dog.
To overcome this dynamic, it was decided to decouple state expenditures from commodity revenues. Since 2004, the ceiling on government spending was set by the budget rule. The new budget policy settled into the Delusions: regardless of real oil prices, the treasury pledged to spend no more than it would have collected in taxes if oil had cost $20 a barrel. By 2007, world oil prices had risen to $80, but the base cutoff price was only raised to $27.
The difference between real and imaginary "base" incomes - the so-called super incomes - did not flow into the economy, but were put aside in the Stabilization Fund. The Fund was supposed to provide the state with a safety cushion in the event of a crisis. In 2008, the $200-billion airbag paid off: half of the money was spent on economic recovery, and Russia got back on the growth track relatively quickly.
After the financial crisis, the budget rule was adjusted with a higher cutoff price, but the Stabilization Fund continued to grow. The state continued to save for a rainy day. By prioritizing budgetary discipline, Russia was accumulating financial resources at the expense of spending real resources. Russians' labor and the country's natural wealth were exchanged for foreign exchange proceeds, while the reduction of productive jobs and stagnant industry were ignored in the name of a budget surplus.
To overcome this dynamic, it was decided to decouple state expenditures from commodity revenues. Since 2004, the ceiling on government spending was set by the budget rule. The new budget policy settled into the Delusions: regardless of real oil prices, the treasury pledged to spend no more than it would have collected in taxes if oil had cost $20 a barrel. By 2007, world oil prices had risen to $80, but the base cutoff price was only raised to $27.
The difference between real and imaginary "base" incomes - the so-called super incomes - did not flow into the economy, but were put aside in the Stabilization Fund. The Fund was supposed to provide the state with a safety cushion in the event of a crisis. In 2008, the $200-billion airbag paid off: half of the money was spent on economic recovery, and Russia got back on the growth track relatively quickly.
After the financial crisis, the budget rule was adjusted with a higher cutoff price, but the Stabilization Fund continued to grow. The state continued to save for a rainy day. By prioritizing budgetary discipline, Russia was accumulating financial resources at the expense of spending real resources. Russians' labor and the country's natural wealth were exchanged for foreign exchange proceeds, while the reduction of productive jobs and stagnant industry were ignored in the name of a budget surplus.
A balanced budget means that expenditures are roughly equal to revenues
Price dividing export revenues into "basic" and "super revenues
Under the existing rules, the budget could be called balanced, but in fact the surplus foreign currency revenues were withdrawn into reserves
The events of eight years ago proved the invalidity of this approach. The post-Crimean period of our economic history was characterized by partial impoverishment and excruciating stagnation. A model of growth based on stability led to the opposite result.
One hundred billion dollars spent from the National Welfare Fund proved powerless in the face of the geopolitical crisis and the collapse of commodity markets. Following the budget rule, the state reduced the growth rate of expenditures while real incomes of Russians fell for eight years.
One hundred billion dollars spent from the National Welfare Fund proved powerless in the face of the geopolitical crisis and the collapse of commodity markets. Following the budget rule, the state reduced the growth rate of expenditures while real incomes of Russians fell for eight years.
The budget policy of the post-Crimea period adopted all the worst practices of the previous fifteen years. The cutoff price in the budget rule was lowered from a hundred to seventy dollars per barrel and below - even less money went into the economy for every barrel sold. The pace of government spending slowed, wages rose slower than prices, demand shrank, jobs disappeared. Keynesian prescriptions were forgotten. The state was worsening the crisis.
Despite the stated goal, the budget rule did not stabilize government spending, but kept it pro-cyclical. Although oil and gas revenues were cut off at an imaginary price, non-oil and gas taxes were collected in full. During periods of high oil prices, the non-oil sector of the economy grew, and with it government revenues. The budget rule obliged the state to inject the received funds into the already growing economy - the budget had to remain balanced. At the same time, the budget policy did not consider its own inflationary effects, the management of inflation was shifted to monetary policy.
The Bank of Russia, which managed the ruble exchange rate with accumulated funds in the pre-Crimean period, abandoned the currency corridor policy and focused on inflation targeting. Until 2014, a stable ruble improved the investment climate and made life easier for consumers, but protecting the exchange rate from the geopolitical crisis proved too expensive in terms of financial resources.
The Reserve Fund no longer even stabilized the ruble exchange rate. It became an untouchable piggy bank of $200 billion. Western analysts have jokingly begun to call the accumulated money "Putin's war chest" - a war chest full of financial instruments. The goal of the stability triad - a balanced budget, low national debt, and inflation targeting - was to accumulate financial resources at the expense of a dramatic slowdown in the growth rate of the real economy. Separately, we should note that it was the period of economic stagnation that contributed the most to the weakening of Russia's geopolitical position and its ambitions of regional leadership.
The Bank of Russia, which managed the ruble exchange rate with accumulated funds in the pre-Crimean period, abandoned the currency corridor policy and focused on inflation targeting. Until 2014, a stable ruble improved the investment climate and made life easier for consumers, but protecting the exchange rate from the geopolitical crisis proved too expensive in terms of financial resources.
The Reserve Fund no longer even stabilized the ruble exchange rate. It became an untouchable piggy bank of $200 billion. Western analysts have jokingly begun to call the accumulated money "Putin's war chest" - a war chest full of financial instruments. The goal of the stability triad - a balanced budget, low national debt, and inflation targeting - was to accumulate financial resources at the expense of a dramatic slowdown in the growth rate of the real economy. Separately, we should note that it was the period of economic stagnation that contributed the most to the weakening of Russia's geopolitical position and its ambitions of regional leadership.
Policies influenced the real variables – employment and demand - through financial instruments. Monetary policy instruments include key rate changes, banking sector reserve requirements, and money supply management in the economy. Monetary-credit policy is also called just a monetary policy
The currency corridor appeared in 1995, when the Central Bank pegged the ruble to the dollar exchange rate, defining the limits of its fluctuation. Prior to the Crimean crisis, the Central Bank was obligated to keep the exchange rate in the range of 36 - 43 rubles per dollar.
Reserve funds during this period were divided and reunited several times
Nowadays
Economic history knows few shocks like the one Russia is experiencing. Unprecedented sanctions and the voluntary withdrawal of private foreign companies make it technically impossible to maintain the former sectoral structure of the economy. The financial resources accumulated over decades have proved ridiculously useless: some of the accumulated funds have been seized by "unfriendly countries" and the possibilities of using the remaining currency are shrinking day by day.
Their list includes nearly 50 world nations, including the U.S., EU, U.K., Canada, and Australia
International relations theory often classifies sanctions as an alternative to violence. In this case, massive sanctions have unequivocally become a form of violence against the Russian population. An exhaustive description of their effects would be beyond the scope of this text; they are too voluminous and varied. However, the question of whether the traditional recipes of stabilization policy can protect the Russian economy from such a blow is quite relevant, not even mentioning the possibilities of post-war reconstruction and recovery.
1. The ban on imports of high-tech products and technical support.
Many of the sub-sanctioned goods - in particular, high-tech means of production - are one-off products manufactured for specific investment projects. Production of such goods is not subject to standardization and is individualized depending on the conditions of further operation. Their supply in the market is controlled by a small number of transnational companies. This also applies to equipment for the extraction of mineral resources.
Russian companies will have to rely on the secondary market and equipment reassembled in friendly countries. The result will be an increase in costs, a drop in the productivity of enterprises and a decrease in the competitiveness of Russian enterprises on world markets.
1. The ban on imports of high-tech products and technical support.
Many of the sub-sanctioned goods - in particular, high-tech means of production - are one-off products manufactured for specific investment projects. Production of such goods is not subject to standardization and is individualized depending on the conditions of further operation. Their supply in the market is controlled by a small number of transnational companies. This also applies to equipment for the extraction of mineral resources.
Russian companies will have to rely on the secondary market and equipment reassembled in friendly countries. The result will be an increase in costs, a drop in the productivity of enterprises and a decrease in the competitiveness of Russian enterprises on world markets.
As well as in case with Iraq, Iran, Cuba and some other states.
In case if they are allowed to at least partially return to them
Import substitution of high-tech areas is impossible without financial costs. Innovations require investments in fixed capital, which involves debt financing and long payback periods. "Responsible fiscal policy" for twenty years has prevented the loss of financial resources, thereby significantly slowing down the innovative development of Russia.
According to the stability triad, innovative development does not require any special efforts - private business will take the initiative when it feels sufficiently solid ground under its feet. But it will hardly work in the current situation. At the very beginning of spring the Government announced that the answer to the restrictions would be the development of imports from friendly countries and local import substitution. As the last six months have shown, both courses of action look more and more like dead ends.
2. A ban on the export of Russian products.
Because of its position in the international division of labor, Russia supplies relatively few science-intensive products and consumer goods to unfriendly countries. It was assumed that European energy dependence would temporarily protect at least raw materials exports, which make up half of the commodity flow. However, the increased discount on Russian oil, new rounds of political escalation, the undermining of the Nord Streams reduce production volumes and commodity revenues much more than the 20% initially assumed by the authorities. It is not clear whether these losses will be somehow compensated in the future.
According to the stability triad, innovative development does not require any special efforts - private business will take the initiative when it feels sufficiently solid ground under its feet. But it will hardly work in the current situation. At the very beginning of spring the Government announced that the answer to the restrictions would be the development of imports from friendly countries and local import substitution. As the last six months have shown, both courses of action look more and more like dead ends.
2. A ban on the export of Russian products.
Because of its position in the international division of labor, Russia supplies relatively few science-intensive products and consumer goods to unfriendly countries. It was assumed that European energy dependence would temporarily protect at least raw materials exports, which make up half of the commodity flow. However, the increased discount on Russian oil, new rounds of political escalation, the undermining of the Nord Streams reduce production volumes and commodity revenues much more than the 20% initially assumed by the authorities. It is not clear whether these losses will be somehow compensated in the future.
Fiscal policy is not the only factor here, but it is fully controllable.
Trade partnerships with friendly countries are complicated by the fear of secondary sanctions. Domestic substitution programs risk being disrupted by the mass departure of a significant number of qualified specialists.
For example, over the past nine months, gas production has fallen by more than 17%, and exports to the Far Abroad have dropped by more than 40%.
The loss of oil and gas revenues to the private sector means a serious blow to the domestic market. Reduced exports risk higher unemployment and lower incomes. Efficiency of the economy will fall due to the narrowness of the market and inability to realize economies of scale. A sharp deterioration in the financial balance sheets of domestic companies will lead to increased risks in the banking sector, which in turn will have a negative impact on the welfare of the population.
For the sake of maintaining a responsible fiscal policy, the stability triad requires a reduction or freezing of government spending (including cuts in social spending) during the crisis. The most that is allowed is a temporary transit period, with reaching the set parameters of normalization by the mid-2020s.
3. Restructuring of logistics chains.
Not all sub-sanctioned goods and means of production have finally disappeared from the Russian market, but the available imports have significantly increased in price. The need to transport goods through "third countries" has increased transportation costs, and the risks of sanctions have significantly increased delivery times and sometimes made it impossible to insure cargo. Each new aggravation leads to higher prices and worsening conditions on the part of private suppliers.
Such shocks will inevitably turn into stages of price increases. The 20% annualized inflation we saw in the spring reflected mostly currency shocks, supply disruptions and a panic-stricken population's frenzied demand. Supply-side constraints will persist as a long-lasting pro-inflationary factor, and heterogeneous spikes with pronounced sector specifics can seriously destabilize the economy.
The stability triad recommends responding to a surge in inflation by raising the key rate in the first place. Under conditions of commodity shortages, production stagnation and organizational chaos, current economic policy suggests making access to credit more difficult, compensating for this with a set of preferential credit programs and write-offs of payments to certain categories of mobilized citizens.
4. Unemployment and personnel shortages
Foreign companies, which for years used a relatively cheap but educated workforce in Russia, are leaving the market, taking with them hundreds of thousands of jobs and the established management culture. Local businesses are gradually downsizing and transferring many employees to part-time work, although traditionally this does not lead to a spike in employment.
During the first few months of hostilities, tens of thousands of highly qualified specialists left Russia, some of them returning in the summer. The triggered mobilization led to the instant departure of already hundreds of thousands of highly productive workers. Such an outflow of labor critically complicates the task of import substitution, which has virtually disappeared from the official rhetoric, giving way to criminal penalties for failure to fulfill the defense order.
Falling wages will reduce household incomes and, if the Phillips curve is to be believed, slow price growth. The flight of people from the country would also obviously reduce current demand. The unfolding crisis in the labor market means that the process of the Russian economy oversimplification will only gain momentum, and the quality of human capital will fall at a faster rate. However, the process of import substitution itself in many respects implies the replacement of more advanced technological processes with obsolete domestic ones. If the sanctions are lifted, such "import-substituting" industry will not be able to compete with foreign manufacturers, which will cause a new surge of tension in the labor market and the economy as a whole.
For the sake of maintaining a responsible fiscal policy, the stability triad requires a reduction or freezing of government spending (including cuts in social spending) during the crisis. The most that is allowed is a temporary transit period, with reaching the set parameters of normalization by the mid-2020s.
3. Restructuring of logistics chains.
Not all sub-sanctioned goods and means of production have finally disappeared from the Russian market, but the available imports have significantly increased in price. The need to transport goods through "third countries" has increased transportation costs, and the risks of sanctions have significantly increased delivery times and sometimes made it impossible to insure cargo. Each new aggravation leads to higher prices and worsening conditions on the part of private suppliers.
Such shocks will inevitably turn into stages of price increases. The 20% annualized inflation we saw in the spring reflected mostly currency shocks, supply disruptions and a panic-stricken population's frenzied demand. Supply-side constraints will persist as a long-lasting pro-inflationary factor, and heterogeneous spikes with pronounced sector specifics can seriously destabilize the economy.
The stability triad recommends responding to a surge in inflation by raising the key rate in the first place. Under conditions of commodity shortages, production stagnation and organizational chaos, current economic policy suggests making access to credit more difficult, compensating for this with a set of preferential credit programs and write-offs of payments to certain categories of mobilized citizens.
4. Unemployment and personnel shortages
Foreign companies, which for years used a relatively cheap but educated workforce in Russia, are leaving the market, taking with them hundreds of thousands of jobs and the established management culture. Local businesses are gradually downsizing and transferring many employees to part-time work, although traditionally this does not lead to a spike in employment.
During the first few months of hostilities, tens of thousands of highly qualified specialists left Russia, some of them returning in the summer. The triggered mobilization led to the instant departure of already hundreds of thousands of highly productive workers. Such an outflow of labor critically complicates the task of import substitution, which has virtually disappeared from the official rhetoric, giving way to criminal penalties for failure to fulfill the defense order.
Falling wages will reduce household incomes and, if the Phillips curve is to be believed, slow price growth. The flight of people from the country would also obviously reduce current demand. The unfolding crisis in the labor market means that the process of the Russian economy oversimplification will only gain momentum, and the quality of human capital will fall at a faster rate. However, the process of import substitution itself in many respects implies the replacement of more advanced technological processes with obsolete domestic ones. If the sanctions are lifted, such "import-substituting" industry will not be able to compete with foreign manufacturers, which will cause a new surge of tension in the labor market and the economy as a whole.
In Russia, unlike in some Western countries, unemployment rates are not very sensitive to the economic situation.
The English economist William Phillips (1914 - 1975) suggested that there is an inverse relationship between unemployment and wages; economists later extended this logic to the general price level. When unemployment falls below a certain level, high employment provokes a rise in prices. Thus it was suggested that the inflation rate should be regulated through the unemployment rate (and vice versa). Later, the Phillips curve was heavily criticized. Nowadays, economists usually recognize a certain correlation between the labor market situation and inflation, but attempts to derive a strict and unchanging function of this kind have ended in failure.
Savings effects of mass production of goods to a large market, allowing the use of advanced labor-saving and energy-saving technologies.
The response to it was a serious restriction on the capital movement from the Central Bank.
What to do? Introductory Remarks.
The initial actions of the Government were aimed at reducing the intervention of the public sector and giving the false freedom to business. This partly coincided with reality - real private investment, seasonally adjusted, fell markedly less than expected, which led to an optimistic revision of the annual rate of economic decline. Budget spending plans were also regularly revised upward.
In spite of the new difficulties, government officials are constantly stating their desire to return as quickly as possible to the "stable" practices of the past era. From the point of view of some conservative economists, the state is indeed limited in funds and therefore forced to optimize expenditures during the crisis. We are sure that this thesis is wrong for the modern Russian economy and its financial system. The measures we propose are based on the following principles:
It is necessary to realize the difference between real and financial resources. Statements like "there is no money, but you hold on" are knowingly false in a monetarily sovereign country. The Russian Federation always has access to an endless supply of rubles - we print them. Fiscal policy is limited only by the availability of real resources: able-bodied population, accumulated real capital, and infrastructure. If there are idle real resources (which is the rule for a capitalist economy, and by no means the exception), the state has the opportunity to "buy" such resources - to create jobs and support production with state orders.
2. A course toward prosperity.
Stability should be a pleasant consequence, not a priority of a healthy economic policy. The priorities should be the well-being of the population, the environmentally balanced use of natural resources, and equal opportunities for the full development of everyone. By sticking to the former course of stability, the country risks being on a new, significantly lower and gentler trajectory of long-term growth.
3. Not just economy.
Economic measures are inherently limited. This text does not claim to be a political program, but rather a set of mechanisms available to political stakeholders. No progressive transformation in the economy is possible without concomitant transformations in society and politics. The writing team acknowledges with regret that unlimited financial resources are useless in the absence of a functioning political apparatus, active citizens, and a vision of the future we seek to create.
4. NO SUBZTITUTE.
The measures below will not help to overcome the effects of sanctions: no country could withstand such an iron curtain. The rhetoric of full and rapid import substitution was originally more optimistic bravado than a guide to action, and is now a thing of the past. Now our task is to avoid the worst under the current constraints, as well as to facilitate an early recovery from the end of the military conflict.
5. There's nothing left to lose.
We don't claim to know what a perfect economy looks like. However, a situation today requires radical experiments and unconventional approaches; crises blur the line between theory and practice. Borrowing a phrase from foreign colleagues, we are left only to cross the river, groping for stones. This text seeks to provide a glimpse of some of the tools available within such an approach.
In spite of the new difficulties, government officials are constantly stating their desire to return as quickly as possible to the "stable" practices of the past era. From the point of view of some conservative economists, the state is indeed limited in funds and therefore forced to optimize expenditures during the crisis. We are sure that this thesis is wrong for the modern Russian economy and its financial system. The measures we propose are based on the following principles:
- Money is there
It is necessary to realize the difference between real and financial resources. Statements like "there is no money, but you hold on" are knowingly false in a monetarily sovereign country. The Russian Federation always has access to an endless supply of rubles - we print them. Fiscal policy is limited only by the availability of real resources: able-bodied population, accumulated real capital, and infrastructure. If there are idle real resources (which is the rule for a capitalist economy, and by no means the exception), the state has the opportunity to "buy" such resources - to create jobs and support production with state orders.
2. A course toward prosperity.
Stability should be a pleasant consequence, not a priority of a healthy economic policy. The priorities should be the well-being of the population, the environmentally balanced use of natural resources, and equal opportunities for the full development of everyone. By sticking to the former course of stability, the country risks being on a new, significantly lower and gentler trajectory of long-term growth.
3. Not just economy.
Economic measures are inherently limited. This text does not claim to be a political program, but rather a set of mechanisms available to political stakeholders. No progressive transformation in the economy is possible without concomitant transformations in society and politics. The writing team acknowledges with regret that unlimited financial resources are useless in the absence of a functioning political apparatus, active citizens, and a vision of the future we seek to create.
4. NO SUBZTITUTE.
The measures below will not help to overcome the effects of sanctions: no country could withstand such an iron curtain. The rhetoric of full and rapid import substitution was originally more optimistic bravado than a guide to action, and is now a thing of the past. Now our task is to avoid the worst under the current constraints, as well as to facilitate an early recovery from the end of the military conflict.
5. There's nothing left to lose.
We don't claim to know what a perfect economy looks like. However, a situation today requires radical experiments and unconventional approaches; crises blur the line between theory and practice. Borrowing a phrase from foreign colleagues, we are left only to cross the river, groping for stones. This text seeks to provide a glimpse of some of the tools available within such an approach.
При желании
A country that issues its own currency, collects taxes in its own currency, and is not obliged to exchange its currency for goods or other currencies at a fixed rate has monetary sovereignty. Russia, China, India, and the United States are to some extent monetarily sovereign countries. Greece and the rest of the Eurozone are not monetarily sovereign because they do not control the issuance of the euro, while Jordan and Iraq have renounced monetary sovereignty in favor of pegging their currency to the US dollar. The French colonies in West Africa gained de jure sovereignty in the process of decolonization, but remained monetary colonies: eight countries continue to use the CFA franc, whose issue is controlled by the French Treasury.
Deng Xiaoping (1904-1997), China's economic successor, compared reform to wading across a river on shaky rocks. "Touching stones" meant looking for patterns by touch, gaining real knowledge through practice. The state apparatus relied on experimental tests, encouraged daring developments, and, by gaining experience, scaled successful discoveries.
Not all entrepreneurs have felt the promised reduction in administrative pressure.
Growing military spending partly accomplishes this task by preventing GDP from dramatic declining.
Key Ideas
1. The requirement to balance the budget is nonsense.
In order to grow and invest, commercial companies borrow money in financial markets. The buildup of debt may create risks for them, but to the extent that debt financing is "justified and reasonable," it is not objectionable. Similarly, consumer and mortgage lending to households is not objectionable.
The same logic fully applies to government. Deficit financing is the norm of a growing economy. Credit is the driver of growth. Even if you hold very conservative views, it is worth bearing in mind that any entity in the economy has current and capital spending, the former is normally financed from current revenues, the latter through debt. This is within the framework of responsible financial behavior and is true for both the private and public sectors.
Budget deficits are no big deal. The question is how it is used. Financing infrastructure construction through public debt buildup, and social assistance through current tax revenues is perfectly normal and fits even into the "cautious" view of fiscal policy.
2. Countercyclical fiscal policy.
The public sector has an essential difference from the private sector - it has (at least by default) no goal to make a profit. This means that the state can show economic activity where the private sector sees losses or low profits. Unfortunately, high profits (or their absence) are not always a symptom of the public utility (or futility) of an activity.
In the context of macroeconomics, this is primarily due to periodic ups and downs in business activity. Business cycles are a constant companion of the capitalist economy, not to mention crashes and crises that occur from time to time. Counter-cyclical fiscal policy - increasing spending (and/or cutting taxes) during recessions, and doing the opposite during booms - is designed to stabilize the economy under such conditions. This stabilizes economic growth and promotes long-term development.
In Russia, despite the presence of certain mechanisms of such a countercyclical policy, in fact, procyclical fiscal policy was in effect due to the combination of the principles of budgetary balance and budgetary rule (see below).
A change in tax policy should also accompany new fiscal approaches. A progressive tax scale is not only a matter of social justice, but also of effective countercyclical policy (especially with regard to corporate taxes).
Rather than seeking to continue adhering to the budget rule, we propose fixing the long-term growth rate of government spending at 3-5%. Thus, they will determine economic growth, serve as an "anchor" in the countercyclical policy and will be adjusted down or up, taking into account inflationary pressure at the end of three-year budget periods.
3. Monetary policy as a support to fiscal policy.
Countercyclical fiscal policy should be accompanied by accommodating monetary policy. The latter should be aimed at managing the exchange rate (fluctuations in world market prices and the exchange rate are the main source of inflation in the economy) and controlling capital flows to stabilize the balance of payments.
Financial markets, with their characteristic rapid capital movements, are often a source of economic destabilization. Capital controls and social control of the financial sector are not out of the ordinary - they were the norm in the developed world in the mid-20th century and are now gradually getting "another breath".
4. Guaranteed Employment and Labor Market Reform.
Russia's labor market is very backward compared to Western economies. The steadily low unemployment figures create a deceptively optimistic impression. In fact, it is a symptom of serious institutional problems: enterprises adjust to economic downturns not so much through layoffs as through reductions in wage bonuses, and vice versa.
This creates grounds for nepotism and grassroots corruption and hampers the development of effective competition mechanisms. The way to solve the problem lies in increasing the social protection of the most vulnerable groups of workers, encouraging independent trade unions and reforming labor relations in general.
5. The economy is not just about interest.
Ideas that the main reference point and goal of development are formal metrics of economic growth or stock market capitalization seem to us a harmful remnant of the neoliberal era. The notion of sustainable development is now widely discussed in many developed countries and in leading international organizations like the United Nations.
It is believed that the result of state activity should be the elimination of at least some environmental threats and problems, the fight against hunger, inequality and lack of access to social benefits, and the implementation of social projects.
We can only agree and emphasize the importance of the social component. As the Russian experience shows, in the absence of functioning political institutions, an active civil society, and the humanization of governance, we can hardly talk about anything sustainable and long-term. A technocratic approach that sacrifices well-being, solidarity, and equality in favor of impressive statistics is a sure path to social disaster.
Below we will elaborate on some of these macroeconomic proposals. Let us add that these are only a few elements, albeit quite important, of the set of necessary reforms.
In order to grow and invest, commercial companies borrow money in financial markets. The buildup of debt may create risks for them, but to the extent that debt financing is "justified and reasonable," it is not objectionable. Similarly, consumer and mortgage lending to households is not objectionable.
The same logic fully applies to government. Deficit financing is the norm of a growing economy. Credit is the driver of growth. Even if you hold very conservative views, it is worth bearing in mind that any entity in the economy has current and capital spending, the former is normally financed from current revenues, the latter through debt. This is within the framework of responsible financial behavior and is true for both the private and public sectors.
Budget deficits are no big deal. The question is how it is used. Financing infrastructure construction through public debt buildup, and social assistance through current tax revenues is perfectly normal and fits even into the "cautious" view of fiscal policy.
2. Countercyclical fiscal policy.
The public sector has an essential difference from the private sector - it has (at least by default) no goal to make a profit. This means that the state can show economic activity where the private sector sees losses or low profits. Unfortunately, high profits (or their absence) are not always a symptom of the public utility (or futility) of an activity.
In the context of macroeconomics, this is primarily due to periodic ups and downs in business activity. Business cycles are a constant companion of the capitalist economy, not to mention crashes and crises that occur from time to time. Counter-cyclical fiscal policy - increasing spending (and/or cutting taxes) during recessions, and doing the opposite during booms - is designed to stabilize the economy under such conditions. This stabilizes economic growth and promotes long-term development.
In Russia, despite the presence of certain mechanisms of such a countercyclical policy, in fact, procyclical fiscal policy was in effect due to the combination of the principles of budgetary balance and budgetary rule (see below).
A change in tax policy should also accompany new fiscal approaches. A progressive tax scale is not only a matter of social justice, but also of effective countercyclical policy (especially with regard to corporate taxes).
Rather than seeking to continue adhering to the budget rule, we propose fixing the long-term growth rate of government spending at 3-5%. Thus, they will determine economic growth, serve as an "anchor" in the countercyclical policy and will be adjusted down or up, taking into account inflationary pressure at the end of three-year budget periods.
3. Monetary policy as a support to fiscal policy.
Countercyclical fiscal policy should be accompanied by accommodating monetary policy. The latter should be aimed at managing the exchange rate (fluctuations in world market prices and the exchange rate are the main source of inflation in the economy) and controlling capital flows to stabilize the balance of payments.
Financial markets, with their characteristic rapid capital movements, are often a source of economic destabilization. Capital controls and social control of the financial sector are not out of the ordinary - they were the norm in the developed world in the mid-20th century and are now gradually getting "another breath".
4. Guaranteed Employment and Labor Market Reform.
Russia's labor market is very backward compared to Western economies. The steadily low unemployment figures create a deceptively optimistic impression. In fact, it is a symptom of serious institutional problems: enterprises adjust to economic downturns not so much through layoffs as through reductions in wage bonuses, and vice versa.
This creates grounds for nepotism and grassroots corruption and hampers the development of effective competition mechanisms. The way to solve the problem lies in increasing the social protection of the most vulnerable groups of workers, encouraging independent trade unions and reforming labor relations in general.
5. The economy is not just about interest.
Ideas that the main reference point and goal of development are formal metrics of economic growth or stock market capitalization seem to us a harmful remnant of the neoliberal era. The notion of sustainable development is now widely discussed in many developed countries and in leading international organizations like the United Nations.
It is believed that the result of state activity should be the elimination of at least some environmental threats and problems, the fight against hunger, inequality and lack of access to social benefits, and the implementation of social projects.
We can only agree and emphasize the importance of the social component. As the Russian experience shows, in the absence of functioning political institutions, an active civil society, and the humanization of governance, we can hardly talk about anything sustainable and long-term. A technocratic approach that sacrifices well-being, solidarity, and equality in favor of impressive statistics is a sure path to social disaster.
Below we will elaborate on some of these macroeconomic proposals. Let us add that these are only a few elements, albeit quite important, of the set of necessary reforms.
Neoliberalism is the informal name for a set of economic measures and practices that became widespread in the mid-1970s. The guiding principle was deregulation, the promotion of market competition, "responsible fiscal policy," and the weakening of trade unions.
What to do right now?
0. Stop the war.
1. Reject the priority of monetary policy over fiscal policy.
To maintain the investment climate, the Bank of Russia should gradually reduce the key rate and fix it at a stable low level (less than 5%). A low and stable rate improves the investment climate and allows businesses to expand the planning horizon, and the necessary adjustment of the economy can be carried out by direct fiscal, administrative and sectoral measures.
High rates are designed to retain capital in the country, thereby supporting the ruble exchange rate. If the rates on ruble accounts are significantly higher than those on foreign currency accounts, the population will keep their savings inside the country. Foreign investors, interested in high yields, will buy liabilities in rubles, maintaining the exchange rate.
Under conditions of a closed capital account, high rates are useless. The population can not withdraw their savings into the currency, foreign investors can not sell ruble bonds, and domestic companies can not go into foreign assets. Unreasonably high rates can provoke a liquidity crisis for local businesses, exacerbating the economic depression.
2. Expand transfers to the poorest segments of the population.
Before the outbreak of hostilities, almost every second Russian denied himself essential goods, including foodstuffs. Every fourth child lived below the poverty line; the next poorest group was pensioners. Under such conditions, most of the social benefits were spent on utilities, medicines and Russian-made food. An increase in benefits and pensions would not lead to a multiplication of inflationary pressure: local businesses, especially food producers, are able to increase supply in response to steadily higher demand.
Increasing benefits is a more effective measure to combat inflation than a price freeze. A price freeze is regressive in nature: it expands the purchasing power of the entire population in the face of an uneven income decline. Increased allowances stabilize the domestic market at a time when a significant portion of export markets has been lost. Sustained growth in the domestic market will create jobs, increase output, and reduce price volatility.
It is also necessary to revise the criteria for making payments: to greatly simplify the procedure for obtaining unemployment benefits, to increase their maximum amount and the duration of payments. In parallel, the minimum wage should be raised in stages, along with the introduction of a comprehensive job guarantee program.
3. Guarantee public works and community service.
Half of Russians have no savings, the other half saves about 10% of their income. Mass unemployment would lead to a humanitarian disaster. Planting trees, cleaning up water bodies and restoring buildings would not replace hundreds of thousands of lost jobs, but it might soften the blow in the short term. By guaranteeing temporary and well-paid work to everyone who wants it, municipal authorities can prevent the marginalization of the unemployed, improve the urban environment for all citizens, and set up chains of mutual assistance.
It is at the municipal, not the federal, level that implementation of the program is critical. Local needs are difficult to predict from Moscow, which means that effective tasks for workers can only be created at the local level. It is enough for the federal government to declare a guarantee for public works and give local governments an unlimited line of credit for the program. This would create a floor for wages in the private sector, maintain consumption levels, and avoid a decline in labor force participation.
In addition, building labor pools of various skill levels would also help with programs related to forced import substitution. It will also be an indispensable measure for the re-socialization of citizens returning from the battlefront, who have a high risk of going into the illegal sector.
4. Intermediary in the trade of essential goods.
Municipalities can take on the role of "market makers" - trade intermediaries connecting producers with buyers.
Unlike commercial intermediaries, a government organization will not seek to maximize profits. Traditional market makers make their money from price fluctuations and therefore their activities inherently involve an element of market speculation, . In the absence of commercial motives, the state structure could play a stabilizing function in the market. It seems particularly promising to us to use such an approach in the food market.
One option for implementation could be a state exchange for the turnover of basic agricultural commodities. The exchange would become one of the buyers of agricultural products and its seller for the processing industry. With the help of such a mechanism the state could curb price increases already at the stage of supply of raw materials to processing companies. Apart from a favorable effect on price dynamics, this would at the same time smooth out "inflationary expectations" of consumers, thus, if successful, eliminating one of the reasons for an aggressive monetary policy.
Another direction could be the organization of model stores owned by municipalities, which would provide a market for the products of small and medium-sized farms. Suppliers would be able to manage the pricing process in real time, relying on an electronic platform to monitor consumer demand, taking into account a fixed relative markup on the costs of maintaining the store.
Such stores could be a good alternative to large chains, whose profits are currently partially deposited abroad, and support small farms, which often have difficulty accessing retail chains.
5. Declare a tax vacation.
In a period of mass shock and technological transition, not only revenues but also private sector savings are under significant pressure. Suspending tax payments (not just temporary postponements) followed by partial or complete write-offs would help to mitigate these effects. First and foremost, the proposed measure should apply to low-income groups and SMEs (small and medium enterprises).
Currently, a significant portion of the taxes paid by entrepreneurs contribute to local, rather than federal, budgets. Unlike the federal government, regional governments are not allowed to issue currency and are therefore limited in their spending. With the introduction of tax vacations, the center needs to provide interest-free and open-ended budget loans to replace the revenue shortfall.
The release of tax funds will be partially offset by an expansion of the tax base in other areas, particularly domestic VAT. Reducing mandatory payments for entrepreneurs would have a positive impact on the savings dynamics and help restore the capitalization of the domestic stock market. It would be reasonable to grant greater tax benefits to those entrepreneurs who face the greatest problems due to rising technical costs and the consequences of mobilization, without access to preferential credit lines.
6. Help business to survive and let it run.
Judging by the rhetoric of the authorities, overcoming the most devastating effects of the current crisis is primarily associated with the potential of the Russian business community. Private business does have many tools available to it, allowing it to respond promptly to changes in the market environment and reallocate resources in the directions that are most in demand. However, the sanctions-military shock being experienced is very different from the usual periodic recessions of the capitalist economy.
In this situation, many companies may be brought to the brink of bankruptcy quite independently of the rationality of their earlier decisions. By assuming a part of the economic losses, the state stimulates future entrepreneurial activity without increasing the risk of moral hazard.
Support measures should be based both on the successful anti-crisis experience of other countries and on the experience of recovery from the global financial crisis. It is necessary to launch a large-scale program of economic revival: the return of specialists who left the country, the restoration of consumer demand, and the avoidance of the most negative social scenarios.
Also for this period it is necessary to increase public procurement in the areas most affected by forced change. Procurement should be aimed at providing material assistance in kind, engaging businesses in state employment and retraining programs, building commodity stocks to manage prices, and generally promoting import substitution programs.
1. Reject the priority of monetary policy over fiscal policy.
To maintain the investment climate, the Bank of Russia should gradually reduce the key rate and fix it at a stable low level (less than 5%). A low and stable rate improves the investment climate and allows businesses to expand the planning horizon, and the necessary adjustment of the economy can be carried out by direct fiscal, administrative and sectoral measures.
High rates are designed to retain capital in the country, thereby supporting the ruble exchange rate. If the rates on ruble accounts are significantly higher than those on foreign currency accounts, the population will keep their savings inside the country. Foreign investors, interested in high yields, will buy liabilities in rubles, maintaining the exchange rate.
Under conditions of a closed capital account, high rates are useless. The population can not withdraw their savings into the currency, foreign investors can not sell ruble bonds, and domestic companies can not go into foreign assets. Unreasonably high rates can provoke a liquidity crisis for local businesses, exacerbating the economic depression.
2. Expand transfers to the poorest segments of the population.
Before the outbreak of hostilities, almost every second Russian denied himself essential goods, including foodstuffs. Every fourth child lived below the poverty line; the next poorest group was pensioners. Under such conditions, most of the social benefits were spent on utilities, medicines and Russian-made food. An increase in benefits and pensions would not lead to a multiplication of inflationary pressure: local businesses, especially food producers, are able to increase supply in response to steadily higher demand.
Increasing benefits is a more effective measure to combat inflation than a price freeze. A price freeze is regressive in nature: it expands the purchasing power of the entire population in the face of an uneven income decline. Increased allowances stabilize the domestic market at a time when a significant portion of export markets has been lost. Sustained growth in the domestic market will create jobs, increase output, and reduce price volatility.
It is also necessary to revise the criteria for making payments: to greatly simplify the procedure for obtaining unemployment benefits, to increase their maximum amount and the duration of payments. In parallel, the minimum wage should be raised in stages, along with the introduction of a comprehensive job guarantee program.
3. Guarantee public works and community service.
Half of Russians have no savings, the other half saves about 10% of their income. Mass unemployment would lead to a humanitarian disaster. Planting trees, cleaning up water bodies and restoring buildings would not replace hundreds of thousands of lost jobs, but it might soften the blow in the short term. By guaranteeing temporary and well-paid work to everyone who wants it, municipal authorities can prevent the marginalization of the unemployed, improve the urban environment for all citizens, and set up chains of mutual assistance.
It is at the municipal, not the federal, level that implementation of the program is critical. Local needs are difficult to predict from Moscow, which means that effective tasks for workers can only be created at the local level. It is enough for the federal government to declare a guarantee for public works and give local governments an unlimited line of credit for the program. This would create a floor for wages in the private sector, maintain consumption levels, and avoid a decline in labor force participation.
In addition, building labor pools of various skill levels would also help with programs related to forced import substitution. It will also be an indispensable measure for the re-socialization of citizens returning from the battlefront, who have a high risk of going into the illegal sector.
4. Intermediary in the trade of essential goods.
Municipalities can take on the role of "market makers" - trade intermediaries connecting producers with buyers.
Unlike commercial intermediaries, a government organization will not seek to maximize profits. Traditional market makers make their money from price fluctuations and therefore their activities inherently involve an element of market speculation, . In the absence of commercial motives, the state structure could play a stabilizing function in the market. It seems particularly promising to us to use such an approach in the food market.
One option for implementation could be a state exchange for the turnover of basic agricultural commodities. The exchange would become one of the buyers of agricultural products and its seller for the processing industry. With the help of such a mechanism the state could curb price increases already at the stage of supply of raw materials to processing companies. Apart from a favorable effect on price dynamics, this would at the same time smooth out "inflationary expectations" of consumers, thus, if successful, eliminating one of the reasons for an aggressive monetary policy.
Another direction could be the organization of model stores owned by municipalities, which would provide a market for the products of small and medium-sized farms. Suppliers would be able to manage the pricing process in real time, relying on an electronic platform to monitor consumer demand, taking into account a fixed relative markup on the costs of maintaining the store.
Such stores could be a good alternative to large chains, whose profits are currently partially deposited abroad, and support small farms, which often have difficulty accessing retail chains.
5. Declare a tax vacation.
In a period of mass shock and technological transition, not only revenues but also private sector savings are under significant pressure. Suspending tax payments (not just temporary postponements) followed by partial or complete write-offs would help to mitigate these effects. First and foremost, the proposed measure should apply to low-income groups and SMEs (small and medium enterprises).
Currently, a significant portion of the taxes paid by entrepreneurs contribute to local, rather than federal, budgets. Unlike the federal government, regional governments are not allowed to issue currency and are therefore limited in their spending. With the introduction of tax vacations, the center needs to provide interest-free and open-ended budget loans to replace the revenue shortfall.
The release of tax funds will be partially offset by an expansion of the tax base in other areas, particularly domestic VAT. Reducing mandatory payments for entrepreneurs would have a positive impact on the savings dynamics and help restore the capitalization of the domestic stock market. It would be reasonable to grant greater tax benefits to those entrepreneurs who face the greatest problems due to rising technical costs and the consequences of mobilization, without access to preferential credit lines.
6. Help business to survive and let it run.
Judging by the rhetoric of the authorities, overcoming the most devastating effects of the current crisis is primarily associated with the potential of the Russian business community. Private business does have many tools available to it, allowing it to respond promptly to changes in the market environment and reallocate resources in the directions that are most in demand. However, the sanctions-military shock being experienced is very different from the usual periodic recessions of the capitalist economy.
In this situation, many companies may be brought to the brink of bankruptcy quite independently of the rationality of their earlier decisions. By assuming a part of the economic losses, the state stimulates future entrepreneurial activity without increasing the risk of moral hazard.
Support measures should be based both on the successful anti-crisis experience of other countries and on the experience of recovery from the global financial crisis. It is necessary to launch a large-scale program of economic revival: the return of specialists who left the country, the restoration of consumer demand, and the avoidance of the most negative social scenarios.
Also for this period it is necessary to increase public procurement in the areas most affected by forced change. Procurement should be aimed at providing material assistance in kind, engaging businesses in state employment and retraining programs, building commodity stocks to manage prices, and generally promoting import substitution programs.
The authors do not find it necessary to economically justify the cessation of hostilities.
Even in the event of a swift, peaceful resolution of the conflict, numerous trade restrictions are likely to remain in place for years to come.
It is impossible to accurately estimate the length of recovery, but it is reasonable to think within the next 3-5 years.
The significant surplus of regional budgets in the first half of the year was caused by growing revenues from oil, gas and coal production. Starting from the end of the third quarter, we can expect a noticeable decline in revenues.
Many of the great economists of the 20th century, including Keynes, argued for the maximum reduction of unemployment, also for sociopolitical reasons. The experience of the world wars clearly demonstrated the dangers of austerity in the presence of large masses of poor people with recent combat experience.
Liquidity implies the ability to pay current accounts, including by means of borrowed funds. Not to be confused with solvency - the ability to pay bills (including credit obligations) by relying on one's own profit.
A market maker is a firm that acts as a broker/dealer and assumes the risk of buying and holding commodities (or other assets, including financial assets).
Less than 2 monthly minimum wages
The concept of moral hazard describes how agents' behavior changes as they guard against the consequences of their actions. Agents who do not expect negative consequences are more prone to risky and frivolous behavior. For example, the U.S. financial sector only built up an appetite for exotic financial instruments after the 2008 crisis - Wall Street well remembered that, if anything happens, the government will bail it out.
What to do tomorrow?
The measures suggested below are not an exhaustive list of all the necessary transformations. Rather, they are some of the key areas along which we believe any successful economic recovery must proceed. It is difficult to estimate the total cost of all the initiatives, but it is obvious that we are talking about tens of trillions of rubles over many (at least five) years. This will be the largest and most expensive project in the history of post-Soviet Russia, the implementation of which will determine our common future, personal well-being, scientific and technological progress and the resulting international influence.
1. Rejection of the Budget Rule.
As MMT makes clear, the state does not need to collect taxes in order to spend money on the needs of society. Spending and taxation are two independent processes. Legislatively tying government spending to annual revenues is akin to deciding to play tennis with your right hand tied behind your back: the rule is arbitrary and contrary to its stated purpose.
With idle real resources (or, more simply, unemployment and business downtime), the government can increase spending without significant inflationary risks. Budget deficits will create financial resources (bonds and cash) that mobilize real resources and allow the economy to be closer to full employment.
It can be difficult for a poor country with an open capital account to maintain budget deficits: Western investors prefer fiscal discipline, and the contradiction of the "Washington Consensus" - the original stability triad - leads to the outflow of foreign capital and the collapse of the exchange rate. Russia faces no such problem today. In fact, the budget rule was suspended this year, but a gradual return to it is expected starting from the next year, 2023.
2. Monetary financing.
The state has three sources of financing expenditures. The first is obvious - taxes. Every year about 50 trillion rubles are collected in favor of the consolidated budget, including about 5 trillion income taxes.
The second method of the state deficit financing is the issue of government bonds for the amount of the deficit. The advantages of this method are that by borrowing from the private sector, the government provides savings instruments to individuals and legal entities. Savings in accounts can evaporate if a bank goes bankrupt; savings in government bonds will disappear only in the event of a deliberate government default. The turnover of government debt increases confidence in the banking system and stimulates investment. From this point of view, "low government debt" is not something to brag about - it just means that there is no established liquid market for risk-free instruments.
1. Rejection of the Budget Rule.
As MMT makes clear, the state does not need to collect taxes in order to spend money on the needs of society. Spending and taxation are two independent processes. Legislatively tying government spending to annual revenues is akin to deciding to play tennis with your right hand tied behind your back: the rule is arbitrary and contrary to its stated purpose.
With idle real resources (or, more simply, unemployment and business downtime), the government can increase spending without significant inflationary risks. Budget deficits will create financial resources (bonds and cash) that mobilize real resources and allow the economy to be closer to full employment.
It can be difficult for a poor country with an open capital account to maintain budget deficits: Western investors prefer fiscal discipline, and the contradiction of the "Washington Consensus" - the original stability triad - leads to the outflow of foreign capital and the collapse of the exchange rate. Russia faces no such problem today. In fact, the budget rule was suspended this year, but a gradual return to it is expected starting from the next year, 2023.
2. Monetary financing.
The state has three sources of financing expenditures. The first is obvious - taxes. Every year about 50 trillion rubles are collected in favor of the consolidated budget, including about 5 trillion income taxes.
The second method of the state deficit financing is the issue of government bonds for the amount of the deficit. The advantages of this method are that by borrowing from the private sector, the government provides savings instruments to individuals and legal entities. Savings in accounts can evaporate if a bank goes bankrupt; savings in government bonds will disappear only in the event of a deliberate government default. The turnover of government debt increases confidence in the banking system and stimulates investment. From this point of view, "low government debt" is not something to brag about - it just means that there is no established liquid market for risk-free instruments.
Today bank deposits up to 1.4 million rubles are insured.
The Washington Consensus is the conventional name for the set of neoliberal economic demands necessary to obtain IMF and World Bank aid since the 1980s.
The above does not apply to external debt denominated in foreign currencies. External public debt poses a danger to public finances and is an obstacle to economic development. The low foreign debt is indeed an advantage for Russia: partly to thank the raw currency revenues, and partly to thank the absence of a colonial past.
In modern economies, government bonds can and are used to expand the money supply, as banks use purchased government bonds in repurchase transactions.
The third method of financing is called monetary financing or monetization of public debt. It is popularly referred to as "money printing. As in the previous method, the government borrows, but not from the private sector, but directly from the Central Bank. The Central Bank creates money in the accounts of the government.
In terms of inflationary pressure, these three methods do not differ from each other: we are convinced that what matters is the total amount of spending, not how it was financed (although traditional economic theory, which assumes complete control of the state over the supply of money, believes the opposite). The government can spend billions of rubles on aluminum and collect billions of rubles in customs duties on textiles - this will not stop price increases, it will only expand them. By financing deficits by issuing bonds, the government provides depositors with a security that can be used as collateral to create more money, which in turn will provoke inflation. Monetary financing, in terms of its macroeconomic effect, is no different from financing from "earned" government revenue.
The legalization of monetary financing would ease the tax burden on the economy and decouple the cost of interest payments on the national debt from the banking sector. It should be noted that the provision of spending through the conditional sale of frozen National Wealth Fund balances to the Central Bank is also essentially monetary financing, but with an intermediate stage.
3. Increasing government spending.
Having stopped artificially restricting itself, Russia will be able to conduct a sovereign economic policy aimed at improving the welfare of the population.
In recent years, Russia has traditionally underutilized the possibilities of fiscal policy. Over the past twenty years, government financial injections in almost every sphere could have improved the lives of the population and accelerated economic growth. Today we face global, long-term, and severe supply-side constraints in many industries. Modern monetary theory cannot help here - it is a crisis of real resources.
However, by following the principles of "austerity" and cutting spending, we will exacerbate social tension, bankrupt many enterprises, and massively reduce demand. This will be a second, internal blow to the production potential of domestic companies, which will significantly reduce the rate of both current and potential growth. The government's current plans call for freezing nominal federal budget expenditures at the 2022 level for the next three years.
Budget support should be directed primarily toward the least well-off citizens. Supporting aggregate demand through social payments may lead to short-term inflation against the background of objective production constraints, but over time, a strong domestic market will help local producers expand production of consumer goods.
A state program is needed to create inexpensive social housing. Affordable housing will support competition in the real estate market and create leverage for consumers to influence developers. Large-scale investment in construction will create jobs and support import substitution in the light industry by increasing demand for Russian building materials. The provision of housing will also become an additional tool for labor management in the labor market.
Social unemployment benefits should provide a decent livelihood. A large part of Russia's population is not able to stay for a long time in search of jobs due to lack of savings and low benefits, which doom people to marginalization in the event of job loss. This prevents competition among employers and forces workers to accept low wages and unhealthy working conditions. Reform in this part is necessary and inextricably linked to the expansion of benefits.
4. Reform of the labor market.
It is necessary to eliminate the large bonus part in the actual wage. Bonuses allow companies to cut costs following market fluctuations: instead of firing people, companies cut actual salaries. This contributes to corruption at enterprises and blunts incentives for technological re-equipment. Adjustment to external fluctuations should take place primarily through fluctuations in the number of people employed in the private sector, rather than through manipulation of the bonus part of the wage. Bonuses should not be taken into account in the calculation of the minimum wage.
The capacity of trade unions must be expanded and strengthened. Labor conflicts must be resolved on a legal basis at the enterprise level, including through strikes and other forms of protest by workers. Strong independent labor is the key to healthy competition in markets and the best way to undermine paternalistic relations in enterprises.
The right to work should be enshrined in the Constitution. The program of guaranteed public works at the municipal level should acquire a permanent institutional status and support temporary jobs in the areas of urban improvement, capital repair, and environmental projects at a flat wage rate. Jobs should be made available to everyone who is willing and able to work: in this way the state would become the employer of last resort. Unlike simply expanding government employment, the program carries no serious corruption risks: by definition, decent jobs will be available to everyone.
Guaranteed jobs will set the floor for wages and social support in the private sector and increase competition in labor markets. The government will be able to effectively manage wages, enforce labor rights on the part of private companies, and avoid the reduction of the working capacity of the population due to long-term suspension of labor activity (this will also help preserve the supply of quality labor for the private sector in periods of economic recovery). In addition, the formation of labor reserves of various skill levels will also help in the implementation of programs related to forced import substitution and overcoming the social consequences of the Special Military Operation.
5. Import substitution.
Budget expenditures should focus on the technological re-equipment of enterprises. The main problems arise in those areas where equipment is manufactured for highly specialized, project-oriented applications. Parts for such goods are difficult to import substitution, so enterprises should be temporarily switched to Russian-made analogues, if they exist, if possible. Such changes will lead to a decrease in productivity, but will buy time to re-evaluate the possibilities of import substitution.
Stratification by category of importance is necessary. The possibilities of internal design and manufacture of technical products are not unlimited. The available production capacity is ample, but insufficient given the scale of forced transformation. We should strive to localize all stages of the technological cycle at least in key industries, including civil aircraft construction, the oil and gas industry and the chemical industry wherever possible.
In the short term, it will be useful to take advantage of China's and India's manufacturing base. Russia will partly continue to rely on technological support from friendly countries. When replacing imports, a high degree of personal responsibility on the part of government officials as well as the introduction of public control mechanisms are particularly critical.
Our long-term goal should be not military but technological mobilization, unequal to traditional import substitution. Effective work in this direction will allow enterprises to interact with new technology markets, share knowledge, and attract foreign capital. The need for massive investment in science and education is self-evident. Support for science in Russia, unfortunately, will often be equivalent to support for the least well-off citizens.
Limited foreign currency proceeds must be spent on goods that cannot be reproduced within the country. The state has no financial restrictions on spending in rubles, but there are very real restrictions in foreign currency. For the sake of these goals, a ban on imports of luxury goods and other low-priority products is reasonable.
6. Initiative budgeting.
The collapse of the social protection system in the Russian Federation has facilitated the development of a number of grassroots civic initiatives. Many of the goals of public policy - assistance to the elderly, sick children, landscaping, and more - are already being implemented to some extent on the resources of citizens themselves. Such organizations represent the interests of the residents themselves and have often already discovered optimal supply chains and methods of support. State intervention would be ineffective.
Part of the state financial resources should be transferred to the municipal budget for proactive budgeting. Area residents can participate directly in the allocation of funds through the tools of direct participatory democracy. Categories of jobs created under employment guarantee programs can also be supplemented and adjusted during public discussions.
7. New methods of fighting inflation.
The main inflation risks over the next 5 years will be on the supply side. Manipulation of the rate under such conditions is not an effective method of controlling inflation, and its frequent changes only increase uncertainty. A high key rate complicates access to credit for businesses and provokes a reduction in output. High interest rates in today's environment have more of a pro-inflationary effect, contributing to a reduction in supply.
At the same time, rate cuts have no decisive effect on the inflation rate, which is especially true in a closed capital account environment. In Russia, the key rate has a relatively weak effect on the volume of non-mortgage consumer lending and does not provoke bursts of excess demand.
The first tool to combat inflation should be the reduction of logistics costs. Investments in infrastructure and supply chains connecting domestic markets as well as government distribution centers are needed.
The second factor of inflationary pressure will remain the ruble exchange rate. Changes in the exchange rate are almost completely transferred to prices. Today the exchange rate is de facto controlled by the government through the largest export companies. Reducing the presence of non-residents on the Russian financial market will relieve the economy from abrupt capital flows, which have always threatened devaluation and, consequently, inflation. As capital flows open up, the task of currency stability should be entrusted to the Central Bank. In the event of capital flight to the dollar and other currencies, the Central Bank should use international reserves to neutralize inflationary pressure on the ruble.
In certain industries, controlling inflation will require restricting consumer demand. Post-Keynesians prefer to prevent excess demand rather than reduce it ex post by raising taxes or the key rate. Preventing inflation requires an analysis of sectoral demand at the planning stage of government spending and evidence-based resource coordination. Like a good dentist, economic policy should address problems before they require crisis intervention.
8. Central Development Institute.
By abandoning active monetary policy as its main task, the Central Bank must accept the role of a development institution. By casting aside the veil of independence, the Bank can become an ally and advisor to economic development. The institution is able to use its expertise and economic instruments to create inclusive economic growth.
In addition to government bonds - the previously mentioned monetary financing - the Central Bank can use its balance sheet to buy bonds of a variety of extra-budgetary organizations, including regional development institutions. Environmental and cultural organizations can issue bonds for long-term capital-intensive projects. These bonds would be redeemed both directly by the Central Bank and by citizens. The inclusion of such bonds in the Lombard list of the Bank of Russia will create a stable and liquid market for instruments of financing sectoral development.
The Central Bank can support the population by creating a liquid and stable market of financial instruments. Individuals will be able to save in government bonds and instruments on the Lombard list. Forming the Lombard list, the Central Bank guarantees the liquidity of savings for the population.
To squeeze aggregate demand in periods of economic overheating, it is appropriate to reduce the volume of lending; however, it should not be done with price instruments. It is appropriate to implement portfolio caps on industries to limit inflation and socially harmful production. Priority projects, on the other hand, should require less provisioning from banks.
9. Control of capital.
Large-scale measures to restrict capital flows, including elements of foreign exchange controls, are often seen as a forced, temporary measure. But there is every reason to believe that the capital controls imposed by the Russian authorities in response to global sanctions can and should become a permanent component of the new economic policy.
Speculative capital flows are often pro-cyclical and exacerbate market volatility. However, capital flows can be linked to macroeconomic policies in the United States and other countries, rather than to the long-term growth potential of our own economy.
After a long period of neglect, capital controls are now getting a second wind. Even conservative institutions such as the International Monetary Fund are beginning to recognize the effectiveness of such restrictions, pointing to the experience of developing countries during the 2008 crisis.
Capital controls will widen the room for economic policy. They will create significant obstacles to carry-trade, reducing the need for international reserves and active monetary policy. Restrictions on direct investment will protect nascent industries and prevent a repeat of the experience of the 1990s, when foreign investors were able to buy up Russian enterprises with the short-term goal of reducing unwanted competition in the global market.
In terms of inflationary pressure, these three methods do not differ from each other: we are convinced that what matters is the total amount of spending, not how it was financed (although traditional economic theory, which assumes complete control of the state over the supply of money, believes the opposite). The government can spend billions of rubles on aluminum and collect billions of rubles in customs duties on textiles - this will not stop price increases, it will only expand them. By financing deficits by issuing bonds, the government provides depositors with a security that can be used as collateral to create more money, which in turn will provoke inflation. Monetary financing, in terms of its macroeconomic effect, is no different from financing from "earned" government revenue.
The legalization of monetary financing would ease the tax burden on the economy and decouple the cost of interest payments on the national debt from the banking sector. It should be noted that the provision of spending through the conditional sale of frozen National Wealth Fund balances to the Central Bank is also essentially monetary financing, but with an intermediate stage.
3. Increasing government spending.
Having stopped artificially restricting itself, Russia will be able to conduct a sovereign economic policy aimed at improving the welfare of the population.
In recent years, Russia has traditionally underutilized the possibilities of fiscal policy. Over the past twenty years, government financial injections in almost every sphere could have improved the lives of the population and accelerated economic growth. Today we face global, long-term, and severe supply-side constraints in many industries. Modern monetary theory cannot help here - it is a crisis of real resources.
However, by following the principles of "austerity" and cutting spending, we will exacerbate social tension, bankrupt many enterprises, and massively reduce demand. This will be a second, internal blow to the production potential of domestic companies, which will significantly reduce the rate of both current and potential growth. The government's current plans call for freezing nominal federal budget expenditures at the 2022 level for the next three years.
Budget support should be directed primarily toward the least well-off citizens. Supporting aggregate demand through social payments may lead to short-term inflation against the background of objective production constraints, but over time, a strong domestic market will help local producers expand production of consumer goods.
A state program is needed to create inexpensive social housing. Affordable housing will support competition in the real estate market and create leverage for consumers to influence developers. Large-scale investment in construction will create jobs and support import substitution in the light industry by increasing demand for Russian building materials. The provision of housing will also become an additional tool for labor management in the labor market.
Social unemployment benefits should provide a decent livelihood. A large part of Russia's population is not able to stay for a long time in search of jobs due to lack of savings and low benefits, which doom people to marginalization in the event of job loss. This prevents competition among employers and forces workers to accept low wages and unhealthy working conditions. Reform in this part is necessary and inextricably linked to the expansion of benefits.
4. Reform of the labor market.
It is necessary to eliminate the large bonus part in the actual wage. Bonuses allow companies to cut costs following market fluctuations: instead of firing people, companies cut actual salaries. This contributes to corruption at enterprises and blunts incentives for technological re-equipment. Adjustment to external fluctuations should take place primarily through fluctuations in the number of people employed in the private sector, rather than through manipulation of the bonus part of the wage. Bonuses should not be taken into account in the calculation of the minimum wage.
The capacity of trade unions must be expanded and strengthened. Labor conflicts must be resolved on a legal basis at the enterprise level, including through strikes and other forms of protest by workers. Strong independent labor is the key to healthy competition in markets and the best way to undermine paternalistic relations in enterprises.
The right to work should be enshrined in the Constitution. The program of guaranteed public works at the municipal level should acquire a permanent institutional status and support temporary jobs in the areas of urban improvement, capital repair, and environmental projects at a flat wage rate. Jobs should be made available to everyone who is willing and able to work: in this way the state would become the employer of last resort. Unlike simply expanding government employment, the program carries no serious corruption risks: by definition, decent jobs will be available to everyone.
Guaranteed jobs will set the floor for wages and social support in the private sector and increase competition in labor markets. The government will be able to effectively manage wages, enforce labor rights on the part of private companies, and avoid the reduction of the working capacity of the population due to long-term suspension of labor activity (this will also help preserve the supply of quality labor for the private sector in periods of economic recovery). In addition, the formation of labor reserves of various skill levels will also help in the implementation of programs related to forced import substitution and overcoming the social consequences of the Special Military Operation.
5. Import substitution.
Budget expenditures should focus on the technological re-equipment of enterprises. The main problems arise in those areas where equipment is manufactured for highly specialized, project-oriented applications. Parts for such goods are difficult to import substitution, so enterprises should be temporarily switched to Russian-made analogues, if they exist, if possible. Such changes will lead to a decrease in productivity, but will buy time to re-evaluate the possibilities of import substitution.
Stratification by category of importance is necessary. The possibilities of internal design and manufacture of technical products are not unlimited. The available production capacity is ample, but insufficient given the scale of forced transformation. We should strive to localize all stages of the technological cycle at least in key industries, including civil aircraft construction, the oil and gas industry and the chemical industry wherever possible.
In the short term, it will be useful to take advantage of China's and India's manufacturing base. Russia will partly continue to rely on technological support from friendly countries. When replacing imports, a high degree of personal responsibility on the part of government officials as well as the introduction of public control mechanisms are particularly critical.
Our long-term goal should be not military but technological mobilization, unequal to traditional import substitution. Effective work in this direction will allow enterprises to interact with new technology markets, share knowledge, and attract foreign capital. The need for massive investment in science and education is self-evident. Support for science in Russia, unfortunately, will often be equivalent to support for the least well-off citizens.
Limited foreign currency proceeds must be spent on goods that cannot be reproduced within the country. The state has no financial restrictions on spending in rubles, but there are very real restrictions in foreign currency. For the sake of these goals, a ban on imports of luxury goods and other low-priority products is reasonable.
6. Initiative budgeting.
The collapse of the social protection system in the Russian Federation has facilitated the development of a number of grassroots civic initiatives. Many of the goals of public policy - assistance to the elderly, sick children, landscaping, and more - are already being implemented to some extent on the resources of citizens themselves. Such organizations represent the interests of the residents themselves and have often already discovered optimal supply chains and methods of support. State intervention would be ineffective.
Part of the state financial resources should be transferred to the municipal budget for proactive budgeting. Area residents can participate directly in the allocation of funds through the tools of direct participatory democracy. Categories of jobs created under employment guarantee programs can also be supplemented and adjusted during public discussions.
7. New methods of fighting inflation.
The main inflation risks over the next 5 years will be on the supply side. Manipulation of the rate under such conditions is not an effective method of controlling inflation, and its frequent changes only increase uncertainty. A high key rate complicates access to credit for businesses and provokes a reduction in output. High interest rates in today's environment have more of a pro-inflationary effect, contributing to a reduction in supply.
At the same time, rate cuts have no decisive effect on the inflation rate, which is especially true in a closed capital account environment. In Russia, the key rate has a relatively weak effect on the volume of non-mortgage consumer lending and does not provoke bursts of excess demand.
The first tool to combat inflation should be the reduction of logistics costs. Investments in infrastructure and supply chains connecting domestic markets as well as government distribution centers are needed.
The second factor of inflationary pressure will remain the ruble exchange rate. Changes in the exchange rate are almost completely transferred to prices. Today the exchange rate is de facto controlled by the government through the largest export companies. Reducing the presence of non-residents on the Russian financial market will relieve the economy from abrupt capital flows, which have always threatened devaluation and, consequently, inflation. As capital flows open up, the task of currency stability should be entrusted to the Central Bank. In the event of capital flight to the dollar and other currencies, the Central Bank should use international reserves to neutralize inflationary pressure on the ruble.
In certain industries, controlling inflation will require restricting consumer demand. Post-Keynesians prefer to prevent excess demand rather than reduce it ex post by raising taxes or the key rate. Preventing inflation requires an analysis of sectoral demand at the planning stage of government spending and evidence-based resource coordination. Like a good dentist, economic policy should address problems before they require crisis intervention.
8. Central Development Institute.
By abandoning active monetary policy as its main task, the Central Bank must accept the role of a development institution. By casting aside the veil of independence, the Bank can become an ally and advisor to economic development. The institution is able to use its expertise and economic instruments to create inclusive economic growth.
In addition to government bonds - the previously mentioned monetary financing - the Central Bank can use its balance sheet to buy bonds of a variety of extra-budgetary organizations, including regional development institutions. Environmental and cultural organizations can issue bonds for long-term capital-intensive projects. These bonds would be redeemed both directly by the Central Bank and by citizens. The inclusion of such bonds in the Lombard list of the Bank of Russia will create a stable and liquid market for instruments of financing sectoral development.
The Central Bank can support the population by creating a liquid and stable market of financial instruments. Individuals will be able to save in government bonds and instruments on the Lombard list. Forming the Lombard list, the Central Bank guarantees the liquidity of savings for the population.
To squeeze aggregate demand in periods of economic overheating, it is appropriate to reduce the volume of lending; however, it should not be done with price instruments. It is appropriate to implement portfolio caps on industries to limit inflation and socially harmful production. Priority projects, on the other hand, should require less provisioning from banks.
9. Control of capital.
Large-scale measures to restrict capital flows, including elements of foreign exchange controls, are often seen as a forced, temporary measure. But there is every reason to believe that the capital controls imposed by the Russian authorities in response to global sanctions can and should become a permanent component of the new economic policy.
Speculative capital flows are often pro-cyclical and exacerbate market volatility. However, capital flows can be linked to macroeconomic policies in the United States and other countries, rather than to the long-term growth potential of our own economy.
After a long period of neglect, capital controls are now getting a second wind. Even conservative institutions such as the International Monetary Fund are beginning to recognize the effectiveness of such restrictions, pointing to the experience of developing countries during the 2008 crisis.
Capital controls will widen the room for economic policy. They will create significant obstacles to carry-trade, reducing the need for international reserves and active monetary policy. Restrictions on direct investment will protect nascent industries and prevent a repeat of the experience of the 1990s, when foreign investors were able to buy up Russian enterprises with the short-term goal of reducing unwanted competition in the global market.
Austerity policy is the approach that economic difficulties, particularly those related to foreign debt, can be solved by reducing government spending. Such ideas largely exacerbated the Eurozone crisis in the early 2010s.
This is what allows officials to talk about effective measures to support employment during the next crisis.
It will also increase labor mobility, which will increase competition for employees and act as an additional incentive to improve the efficiency of the production technologies used.
Despite their formal independence, the Central Bank and the government are extremely dependent on each other's decisions and, as a result, are forced to pursue a coordinated policy with common goals.
Similar programs, mainly related to the localization of microelectronics production, as well as "debottlenecking" of logistics, have been launched in recent years in the U.S. by the Biden administration.
The list of assets that the Central Bank takes on its balance as collateral for lending to commercial banks.
By pricing instruments in this case we mean interest rate management. Changes in the key rate affect the entire yield curve in the economy, while inflation is often linked to bottlenecks in individual industries or import positions. It is in this sense that targeted measures are needed to "tap" such problems instead of "carpet bombing" in the form of rate manipulation.
Such a program would provide guaranteed, but not forced, jobs: access to unemployment benefits would remain free for all citizens, regardless of participation in an employment guarantee program.
Other key industries include radio electronics, a certain set of computing machines and their components, manufacturing tools, and pharmaceuticals.
Participatory democracy is a form of democracy that gives citizens the right to participate not only in referendums and the selection of representatives, but in every stage of the political process: the preparation, adoption and implementation of decisions, as well as the monitoring of their implementation. Mechanisms of participatory democracy include public consultations, participatory planning sessions, and decentralization of political processes.
A strategy for profiting in the foreign exchange market by varying interest rates
The practice of excessive accumulation of reserves should come to an end. It is enough to be limited to the amount necessary to cover the 6-month import requirements and payments on foreign debt.
What to do in the future?
This chapter is in drafting.
