Russian Federation: Selected Issues

The Selected Issues paper on the Russian Federation discusses the economic growth and future growth potential of the country. After almost a decade of impressive growth performance, Russia suffered a sharp contraction in 2009 with GDP falling by 8 percent. This paper gives an overview of the conceptual issues regarding potential growth and the analytical framework based on an exogenous growth model; growth accounting results for Russia in the past decade; and importance of structural reforms to achieve sustained high growth.

Abstract

The Selected Issues paper on the Russian Federation discusses the economic growth and future growth potential of the country. After almost a decade of impressive growth performance, Russia suffered a sharp contraction in 2009 with GDP falling by 8 percent. This paper gives an overview of the conceptual issues regarding potential growth and the analytical framework based on an exogenous growth model; growth accounting results for Russia in the past decade; and importance of structural reforms to achieve sustained high growth.

II. Making Russian Monetary Policy More Effective

A. The CBR’s Policy Interest Rate Corridor—How Wide Should It Be?1

Over the past 12 months or so, the Russian money market has moved from a structural surplus of liquidity to a structural shortage, as reduced foreign exchange interventions coupled with a reduction in net credit to government drained the surplus liquidity. The central bank has taken the opportunity to introduce active use of an open market operation to guide short-term rates, and to provide a greater degree of short-term stability. This should enhance the effectiveness of the central bank’s interest rate levers, improve monetary transmission, and promote market development. The change in market structure provides an ideal occasion to review the operational framework of monetary policy, rationalizing the number of instruments and reviewing the width of the policy rate corridor.

1. Most central banks use interest rate levers—the interest rate on transactions between the central bank and its financial market counterparties—to guide short-term interest rates in the wholesale money markets and thus, indirectly, to influence both longer-term money market rates and the interest rates used by banks and other financial intermediaries in their transactions with the wider economy.

2. The Central Bank of Russia (CBR) has for some years been working to increase the effectiveness of interest rate levers in the Russian economy, allowing it to move from the reliance on a stabilized exchange rate which had characterized the CBR’s approach in the 1990s. From 2000 onwards until mid-2011, the Russian money market had a substantial surplus of liquidity,2 and the CBR made available standing facilities for both credit and deposits. Under the circumstances of surplus liquidity, short-term interest rates tended to be anchored by the central bank’s liquidity absorption rate and at a relatively low level—as in many other emerging markets. But when there was a capital outflow, the CBR—like many central banks—sold foreign exchange to smooth the impact on the exchange rate, with the counterpart to the sale of foreign exchange seen in a reduction in commercial bank balances at the central bank. In periods of strong capital outflows, there has been a large degree of interest-rate volatility, as the market experienced a temporary shortage of reserve money and short-term interest rates consequently jumped to (and on occasion above) the ceiling rate—as can be seen in Figure 1 below.3

Figure II.1.
Figure II.1.

Russian Money Market Daily Interest Rates

Citation: IMF Staff Country Reports 2012, 218; 10.5089/9781475505047.002.A002

Source: Central Bank of Russia data
Figure II.2.
Figure II.2.

U.K. Policy Rate Corridor and Overnight Interbank Rates

Citation: IMF Staff Country Reports 2012, 218; 10.5089/9781475505047.002.A002

Source: Bank of England data

3. In order to increase the effectiveness of monetary policy interest rates, many central banks find it important to provide greater clarity on the setting of policy rates (clarifying the central bank’s monetary policy reaction function) and to reduce the volatility of very short-term rates. This allows the market to take a view on future policy rate developments, and means the “noise” of short-term volatility does not obscure the pass-through from short-term rates to longer-term yields. Narrowing the policy interest rate corridor will, mechanically, reduce short-term interbank rate volatility. But achieving a stable market rate in conditions where the market will reliably pass the policy rate on to the rest of the yield curve also requires enhanced liquidity management by the central bank, and in many cases also benefits from a move away from structural surplus liquidity to a shortage. The move in 2011 to a shortage of reserve money in the Russian market has set the stage for a reduction in short-term rate volatility. This chapter discusses the width of policy rate corridors as part of the central bank’s operational framework to implement monetary policy effectively.

Background

4. Central bank monetary policy setting prior to the outbreak of the financial crisis in 2008 would normally be centered on the targeted level for short-term interbank or wholesale money-market interest rates. Some central banks expressed policy in precisely such terms (e.g., the U.S. Federal Reserve Bank, the Bank of Canada, the Reserve Bank of Australia). Others announced policy in terms of an open market operation rate at which the central bank would transact with its counterparties, with an expectation that short-term market rates would trade close to this level—perhaps within 5–10 basis points (the ECB, the Bank of England, the Reserve Bank of New Zealand but also a number of Emerging Market (EM) central banks).4

5. In other cases, the central bank would announce a standing credit facility rate,5 but market rates traded—and were expected to trade—well below this level.6 Virtually all central banks make available a standing credit facility, as this is important from a payment systems point of view. It prevents the risk that a shortage of reserve money at one bank might force the unwinding of payment orders made throughout the day. In practice, its role as a payment system safety valve means that the interest rate on the credit SF does not have a central function for monetary policy purposes. Reflecting this purpose, the credit SF is nearly always for an overnight maturity, and carries a penalty rate high enough to motivate effective liquidity management by commercial banks.

6. But not all central banks make available a deposit SF. It is not necessary from a payment system point of view (because excess reserves balances do not cause a payment systems problem); and provided liquidity can be managed sufficiently well (typically via a combination of OMO and reserve requirement averaging), interest rates may still be guided by the OMO rate. The USA was an example of this prior to October 2008.7

7. Systems which use standing credit and deposit facilities to inject and to withdraw reserve money are typically referred to as either “corridor” systems, or “floor” systems.

Corridor System

8. The term “corridor” system is used where the central bank sets upper and lower bounds for (most) overnight wholesale money market transactions by making available standing credit and standing deposit facilities, with overnight maturities. In most cases, these are set at symmetric margins around the announced policy rate. But the expectation—at least pre-crisis—was that actual short-term market rates would be steered within a much narrower band, in line with the policy target and in the middle of the corridor, by use of open market operations (OMO).

9. The U.K. provides an interesting example of the introduction of a corridor system in 2006. A decision was taken in 2004 to restructure the operational framework for monetary policy implementation in order to deliver a relatively stable overnight interbank rate in line with the policy target. High volatility could obscure the monetary policy stance. Moreover, by setting a high barrier to market participation,8 it reduced competition in the interface between the central bank and the wider economy. Because the full money market reform—involving averaging of contractual reserves, amongst other features—would take some time to implement, a narrow corridor was introduced as an interim measure. This reduced but could not eliminate volatility (cf., the narrowing of the corridor in Russia over the past decade or so, shown in Figure 1). With the introduction in May 2006 of enhanced liquidity management under the new monetary policy framework,9 a substantial degree of market stability was achieved, permitting the central bank to widen the policy rate corridor from +/-25bp to +/-100bp, stimulating more market activity but without causing interest rate volatility.

Floor System

10. The term “floor” system is used where there is an asymmetric corridor. The upper and lower bounds to market rates are still set by standing facilities; but there is no OMO undertaken at the middle of the corridor (or at least, not in sufficient volume to steer interest rates to this level); and the expectation is consequently that market rates will be close to, but somewhat above, the deposit SF. Central banks do not run “ceiling” systems in normal times, though when faced with exchange rate pressures central banks will for a period allow interest rates to rise towards the ceiling of the policy rate corridor. A floor system may be a result of weak liquidity management, or a policy decision not to pay the price of draining reserve balances surplus to demand, or a policy of Quantitative Easing (QE) or unsterilized exchange rate intervention.

11. Pre-crisis, floor systems were more common in EM countries, though they were also used in a few Advanced Economies (Norway is the notable example). The chart (Figure 3, below) of interest rates in India shows distinct phases: a floor system in 2009 and early 2010, with rates close to or below the floor; a “floor system” but reacting to periodic shortages of liquidity as a result of foreign exchange flows, from mid-2010 until mid-2011; and the introduction of a “corridor” system from mid-2011. The overall picture is very similar to that for Russia. (Note that on occasions in India the overnight market rate was below the floor. This can happen if, for example, the overnight deposit facility is not available until the payment system closes; a bank may not be aware it holds surplus liquidity until too late in the day to make use of the facility.)

Figure II.3.
Figure II.3.

India: Policy Interest Rate Corridor and Overnight Interbank Rates

Citation: IMF Staff Country Reports 2012, 218; 10.5089/9781475505047.002.A002

Source: Reserve Bank of India data

12. A market with a structural surplus of reserve money which is not fully drained by the central bank’s open market operations will effectively operate as a floor system, because banks expect to have to leave a significant volume of reserves in the overnight deposit facility. By contrast, markets with an ex ante reserve money shortage are most likely to operate as a “corridor” system—where OMO are used actively to keep short-term market rates in line with the targeted policy rate. In part, this is because some central banks are more willing to inject liquidity via OMO than to drain it, since they earn a return by lending but have to pay the cost of draining. More generally, central banks typically view the standing credit facility as “last resort” borrowing, which should carry a penal rate; and by definition it would not be a penal rate if the market regularly traded at that level. In any case, the central bank will virtually always supply reserve money via one channel or another—notably, to prevent disruptions in the payment system—so “ceiling” systems are not found.10

13. This suggests that what matters most for monetary policy implementation is the marginal rate at which the market expects to transact in substantial volume with the central bank. Some of the literature suggests that the market rate is determined as the average of the SF rates, rather than being determined by the OMO rate. But this is not borne out by the evidence, either in Russia or elsewhere.

  • If there is no OMO, market rates tend to trade either around the floor or, in times of market stress, around the ceiling, rather than being stable around the average of the two (as illustrated in Figures 1 and 3, above).

  • If an OMO is actively used, but the central bank did not (or do not) set a floor rate, the short-term market rate is rarely the average between the credit SF rate and zero; it is typically either around the OMO rate, or close to zero (the floor).

14. In summary, regular and substantial use of one or other of the SFs will tend to push the market rate to the boundary of the “corridor” (typically, the floor), whereas if there is an expectation that use of standing facilities will be trivial, then the SF rate is unlikely to impact the market rate directly: the OMO rate should then guide the market.

15. If the central bank could manage liquidity perfectly, so that the market always expected to transact with the CB only at the policy rate and never at the SF rates, it would not matter how wide the corridor is, since the SF rates would effectively be irrelevant. The corridor width is relevant, however, whether because the CB cannot manage liquidity perfectly—especially in times of severe market stress—or because it uses a floor system rather than targeting the center of the corridor.

Temporary Switch from Corridor to Floor

16. In the context of the financial crisis, some Advanced Economy (AE) central banks have moved, temporarily, from corridor to floor systems, as reserve money balances have been expanded substantially—whether as a counterpart to Quantitative Easing (QE) purchases of government securities, or central bank intermediation between banks in face of a continued weakness of the interbank market. The U.S., the Euro area and the U.K. are examples of this. For these central banks, a change in circumstances—in this case, a major financial sector shock—means that a temporary move to a floor system makes good sense, as the demands of financial sector stability outweigh the benefits for monetary policy transmission and market development of a corridor system. The weakened transmission from short-term policy rates to the wider economy is not an immediate concern, in view of weak inflationary pressures against a background of low economic growth; but will make policy implementation more complex if inflationary pressures arise before the surplus reserve balances have been absorbed.

Several Countries Have Moved From a Floor to a Corridor System

17. In Russia, a structural shift in market liquidity was seen through 2011, starting in April but being evidenced most clearly from late September when the repo OMO lending came regularly and substantially into play, with a consequent impact on the overnight market rate.11 A marked slowdown in the level of official foreign exchange purchases—and occasionally net sales of reserves in the face of continued capital outflows—coupled with a reduction in net credit to government had drained surplus reserve money balances from the commercial banks, resulting in an overall market shortage and facilitating a move towards a corridor system. When the CBR sold foreign exchange to support the foreign exchange markets in the late summer of 2011, this operation drained domestic currency reserves (because the commercial banks have to pay for the foreign exchange). At the same time, an increase in net government balances with the CBR and an increase in currency in circulation together drained some rubles 2.3 trillion liquidity from the market in 2011. Figure 4 below indicates a few points from April to September 2011 when the market was temporarily short of liquidity, resulting in a spike in interbank rates; and then from September 2011a consistent move to a shortage allowed the shift to a corridor system of operation, with interbank rates trading much closer to the overnight repo OMO than to the floor.

Figure II.4.
Figure II.4.

Russia, Short-Term Interest Rates in 2011

Citation: IMF Staff Country Reports 2012, 218; 10.5089/9781475505047.002.A002

Figure II.5.
Figure II.5.

Russia, Key Items in CBR Balance Sheet, 2011 in Rubles Billions

Citation: IMF Staff Country Reports 2012, 218; 10.5089/9781475505047.002.A002

Source: Central Bank of Russia data

18. A number of other EM countries experiencing capital outflows in 2008–09 or later saw a similar shift in structural liquidity balances. In such conditions, when the central bank becomes a regular supplier of liquidity to the market, it tends to be easier to operate a corridor system.

19. A similar pattern can be seen in India. In this case, there were two important factors in bringing the overnight interbank rate into the middle of the interest rate corridor. First, the central bank took a policy decision to pull back from exchange rate intervention, allowing greater market determination of the exchange rate, and sold some foreign exchange when dollar funding pressures were high in 2008–09. Since official purchases of foreign exchange were no longer generating domestic currency liquidity, the trend increase in demand for reserve money quickly moved the market to a structural shortage, giving the central bank stronger leverage. Second, and following on from this, the central bank adjusted the structure of its operations, using an open market operation to guide market rates to the middle of the corridor and so reduce volatility—Figure 6 below.12

Figure II.6.
Figure II.6.

India, Short-Term Interest Rates in 2011

Citation: IMF Staff Country Reports 2012, 218; 10.5089/9781475505047.002.A002

Source: Reserve Bank of India data

20. In this case, the RBI took advantage of the change in circumstances to introduce a permanent enhancement to its operational framework. Another, somewhat older, example is that of the Croatian National Bank which in 2005 adjusted the way in which reserve requirements are met in order to move the market from a structural surplus to a structural deficit of domestic currency reserves, and giving the central bank greater control over short-term market rates through the use of liquidity-providing OMO.13

Determining the Corridor Width

21. Global practice regarding the width of policy rate corridors varies substantially.

Table II.1.

Policy Rate Corridors

article image

Too Wide?

22. If liquidity management is potentially difficult, so that a lending bank has a material degree of uncertainty regarding its own liquidity management, and may assume that counterparts also face similar uncertainties, the probability of needing to access the central bank’s standing credit facility will be increased. If the marginal cost of accessing this facility is too high (too “penal”), then banks have an incentive to increase liquidity buffers in order to avoid this cost, instead of trading. (This behavior is sometimes described as ‘liquidity hoarding’; but is often a rational response to market circumstances, including the central bank’s operational structure, rather than perverse behavior.) For instance, a gain of 50bp in interbank overnight lending every day of the week would be more than offset if the lending bank had to access a credit SF at 300bp over the effective policy rate once a week, even without taking account of the cost of holding eligible collateral.

Too Narrow?

23. Does it matter if the corridor is too narrow, such that the market has no incentive for short-term market trades? This may be of secondary importance from an immediate policy perspective: short-term rates should still be in line with the policy goal. But central bank intermediation is collateral intensive, since the central bank will demand collateral from borrowing banks. This places a deadweight cost on financial intermediation, and may reduce the secondary market liquidity of securities accepted as collateral. There is also a risk that the central bank may be inclined to offset these costs by accepting second-rate collateral. This could result in a degradation of the quality of collateral held by the banking system as a whole.

24. The above reasoning suggests that both corridors that are too narrow and those that are too wide will discourage interbank trading, and will tend to dampen market and yield-curve development, weakening the transmission of interest-rate based monetary policy.

What Size of Interest Rate Spread is Significant?

25. It is common to argue that Standing Facility rates should be “penal,” in order to discourage market intermediation via the central bank. This indicates the central bank needs to be able to judge what “penal” implies for a given market. In normal market conditions, important factors to take into consideration are: the size of trades, the cost of trading, and the cost of alternatives.15

26. Even if it is assumed that there is zero credit and liquidity risk associated with the trade, the back-office costs of settling may well exceed such a return. This is even more likely to be the case if the deal is secured (e.g., by repo) as the settlement costs of repo transactions (including any fees payable to the securities depository) are greater than those for unsecured interbank transactions. If there is a perception of liquidity risk, the return will need to be correspondingly higher. There may also be a matter of convenience: if transacting with the central bank has a low opportunity cost, it may be cheaper than paying for a dealing room and the middle office necessary to use the interbank or wholesale markets.

Central Bank of Russia Rate Structure

27. In Russia, as in many countries, there appears to be certain segmentation in the interbank markets, particularly for bilateral deals.16 A small number of large banks will deal with each other in large volume (perhaps several billion rubles), whereas the greater number of small banks may deal for a hundred million rubles or less. A spread which was (reasonably) penal for small banks may be excessively penal for the larger market participants. In such a case, it may be best for the central bank to structure its system in a way that takes more account of the large trades, because they will have a greater impact on the overall economy. For Russia, this would point to a narrower spread in order to optimize incentives for the larger banks to trade in the market, even if a number of smaller banks then became more reliant on central bank lending facilities.

28. The Central Bank of Russia’s policy rate structure at end 2011—see Table 2, below—indicates the use of several different interest rates each for Standing Facility lending, Standing Facility deposit, and Open Market Operations, as well as a range of different maturities and collateralization models. The multiplicity of official rates in Russia, while reduced from earlier levels, remains unusual by international comparison. This makes it difficult to know if the corridor (or corridors) is/are too wide or too narrow, whether for certain types of banks or for the banking system as a whole. It significantly complicates the task of assessing whether the rate spreads are appropriate, as well as complicating the transmission from overnight rates to longer-term market rates, since it will not be clear to the market precisely what the central bank is aiming to achieve with this complex structure of instruments. Indeed, shifts in structural liquidity mean that the structure will have a varying impact over time.

Table II.2.

Central Bank of Russia Interest Rates

article image

7 days fixed rates REPO operations have been suspended.

Operations have been suspended.

Operations were suspended from 10 February 2011, resumed from 1 November 2011.

Updated December 23,2011.

29. Narrowing the focus to overnight transactions, the overnight (up to 7 day) repo OMO rate was 5¼ percent: this was 125bp above the overnight deposit SF, but 275bp below the higher of the overnight credit rates. This gives a 400bp wide, asymmetric corridor for overnight operations—assuming this is the most appropriate general indicator of the operational framework for the market as a whole—which is a wide spread by comparison with other markets.

30. This said some progress has been made in recent periods with the shift of the effective policy rate to the middle of the corridor. When the framework was operating as a floor system—until 2011 QIV—the spread of nearly 400bp between MIACR and the higher Standing Facility ceiling appeared to be too high (since it would motivate banks to “hoard” liquidity rather than risk paying such a high rate). With the move to a more symmetric corridor system, the spread between MIACR and the Standing Facility ceiling was halved; and for banks which could use the fixed-rate repo facility at 6.25 percent, the effective spread was little over 100bp. With a broadly symmetric and smaller opportunity cost of using the Standing Facilities in case of need, banks should be more likely to make use of the interbank market. However, further progress can likely be made, including by simplifying the policy rate structure.

Narrowing of the Corridor?

31. Whatever the rationale for determining the corridor width in normal times, the width should at least be reviewed periodically, to ensure the structure takes account of market developments; and in times of market stress. Since 2007, a number of central banks have reduced the corridor width temporarily, judging that there is value in reducing short-term rate volatility from heightened levels, and that while interbank markets have become dysfunctional, or at least are weaker than previously, a wider corridor would not address the main causes of problems in the interbank market (increased perception of credit risk, increased liquidity risk). As liquidity uncertainties in the market meant that market intermediation could not be relied on to manage liquidity, the SF rates took on a new importance. This is a temporary phenomenon, but important for use during stressed circumstances.

  • The U.S. Federal Reserve Bank cut the spread between its target rate (the Fed Funds Rate) and the credit SF (the Primary Credit Facility, known as the Discount Window) from 100bp to 50bp in August 2007, and further reduced it to 25bp in March 2008.17 It was increased back to 50bp in early 2010 as interbank pressures eased (in part because of the large volume of liquidity injection arising from the Quantitative Easing program). Published data indicate that when the spread was increased to 50bp, banks made less use of the PCF and increased the volume of interbank transactions. Note that in the USA at present, 50bp represents the full width of the corridor between the rate paid on excess reserves (25bp) and the rate charged for SF credit (75bp).

  • The ECB18 operated a corridor of +/-100bp from 1999 to 2008. This was narrowed to +/-50bp in October 2008 in face of strong short-term rate volatility; restored to +/-100bp in January 2009 but then narrowed to +/-75bp as the markets failed to sustain a recovery. However, it may be argued that, since the introduction of fixed-rate, full-allotment OMO tenders in October 2008, the OMO lending rate has functioned in large measure as an SF rate, so that the effective corridor width is 75bp.

  • The Bank of England introduced a narrow corridor of +/-25bp in 2004, prior to the introduction of a reserves averaging system in May 2006, in order to limit overnight interbank rate volatility ahead of the introduction of the new system. Once the reserves averaging system was introduced, the corridor was widened to +/-100bp as liquidity management was from that point capable of keeping actual overnight rates within a tight bank around the policy rate. The spread was narrowed to +/-25bp in 2008, in the face of strong market volatility. When the policy rate was cut to 50bp in March 2009, the corridor effectively became 25bp wide, as all reserves are remunerated at the policy rate, so this operates as a deposit SF.

32. With a floor system, the width of the corridor needs to be re-evaluated, since the gap between the market rate and the credit SF is no longer half the width of the corridor, but (almost) the whole width.

Conclusions

33. The width of corridor matters more to the extent that (i) market participants expect to use standing facilities more, whether because there is no OMO, or because OMO and other liquidity management tools cannot be relied on to keep the balance between supply of and demand for reserve money within a sufficiently narrow band; and (ii) the width of corridor matters more if the market is segmented, such that liquidity-rich banks may not be prepared to lend to liquidity-short banks.

34. In addition, it seems clear that transactions in the interbank market will be discouraged if the corridor is (i) too narrow, because the benefits for liquidity-rich banks from dealing in the market do not outweigh the benefits of using the central bank as an intermediary; or (ii) too wide, because the opportunity cost of being short of reserve balances motivates a “hoarding” of liquidity.

35. Further, it appears that, for all markets, a corridor narrower than +/-25bp is too narrow to motivate interbank transactions. If the corridor is to be wider than+/-100bp, the central bank should be reasonably clear that a wider spread will incentivize interbank transactions (or reduce exchange rate pressures), rather than motivating hoarding of liquidity.

36. For Russia (as with some other countries), where there is a case for reducing the corridor width in order to facilitate more interbank activity, it is not possible to be certain ex ante what the ideal corridor width is. Russia is in a ‘learning mode’, as the central bank and the market adjust to a structural liquidity shortage, on top of coping with a very uncertain international environment. It makes sense for the central bank, in such a situation, to reduce the corridor width gradually and monitor the market response. Where—as in Russia at present—the system is operating as a corridor system, raising the floor and lowering the ceiling may be a largely technical move, as there should be no expectation that market rates would change (though the central bank would nevertheless need to communicate clearly to the market that this was intended as a technical move reflecting the changed market structure). By contrast, raising the floor rate in a floor system would imply a policy change; and lowering the ceiling rate—even if the standing credit facility was rarely used—would risk being interpreted as a policy easing, especially if the central bank has in the past referred to this rate as the “policy” rate. Our judgment is that a reduction in the corridor width to around 200bp would be appropriate for the Russian markets at the current juncture; but, while the central bank is in “learning mode” and account needs to be taken of a number of changing factors in both the domestic and international markets, the central bank should proceed cautiously and with regular re-evaluation of the situation.

37. Finally, rationalizing (reducing) the number of policy rates and maturities should make it easier to interpret the market’s response to any adjustments, and thus to gauge whether further changes would be beneficial.

B. Managing Expectations—Improving the CBR’s Communication Policy19

Good communication can greatly improve the effectiveness of monetary policy. In recent years, the CBR has made important progress in its communication but considerable room for further improvement remains. In particular, the CBR could usefully publish its inflation projections and minutes of policy meetings. Overall communication would also benefit from consistency in the messages sent by the CBR and others.3

38. Communication policy is an important instrument in a central bank’s toolbox. This is because central bank communication can shape expectations about monetary policy, future market conditions, the levels of interest and exchange rates, and, crucially, inflation.

39. Central banks have been moving to greater transparency. In the past, central banks have often been rather secretive and it was believed that policy effectiveness depended on “taking markets by surprise.” Over the past twenty years, however, mainstream economic thinking on this matter has changed drastically, and many central banks—in particular inflation targeting central banks—have moved to much greater transparency.20

40. Good communication can improve the effectiveness of monetary policy. In part, the trend toward greater transparency has been driven by a call for accountability of increasingly independent central banks. However, an equally important driver has been the realization that central bank communication can greatly enhance the effectiveness of monetary policy. Relatively few transactions in the economy take place against the overnight interbank interest rate that is the operational target of many central banks and the main mechanical point of traction for monetary policy. For economic activity, it is generally more important how long-term interest rates and the overall yield curve are affected by the central bank’s actions. This, in turn, critically depends on the public’s expectations about the future path of short-term interest rates and the future policies of the central bank. Indeed, leaving aside quantitative easing, it is only via expectations that the central bank can influence longterm rates. Managing expectations is therefore a key task of any central bank.

41. Anchoring expectations is key for commodity exporters. In commodity exporters—many of which in advanced economies are inflation targeters (e.g., Australia, Canada, New Zealand)—managing, and anchoring, expectations about future conditions and inflation may be even more important, so as to dampen the short-term macroeconomic volatility that can ensue from volatile commodity prices.

42. Central banks can communicate on several topics. In order to shape expectations about future conditions and policies, central banks may consider communicating in a few broad areas.

  • First, a central bank can communicate its policy objective and strategy. For instance, an inflation targeting central bank would typically reveal in rather precise terms its inflation target, as well as the time horizon over which the target is to be achieved. A well-known example is the ECB’s objective to keep the inflation rate below, but close to, 2 percent over the medium term.

  • Second, a central bank can explain, in various degrees of detail, the rationale for current and past policy decisions and the process through which decisions have been reached. Examples of this type of communication include post policy meeting statements (CBR) or press conferences (ECB) to explain interest rate decisions, and the publication of central bank meeting minutes (Federal Reserve, Bank of England).

  • Third, a central bank can share its views on current economic conditions and the economic outlook. Owing to their specific expertise and resources, central banks may have superior information about economic conditions and prospects and sharing this information with the public can help the latter better understand the state of the economy. 21 In addition, such information reveals the central banks interpretation of current and future conditions, which allows the public to understand and anticipate potential future policy actions. For instance, in this context most inflation targeting central banks publish inflation forecasts, sometimes in the form of “fan charts” that also give a sense of inflation risks surrounding the baseline forecast (e.g., Bank of England, Norges Bank). Information about inflation expectations of the public can also be highly informative and is published by some central banks (e.g., Federal Reserve Bank of New Zealand).

  • Fourth, a central bank may communicate directly on the outlook for future monetary policy. For instance, some central banks have indicated easing or tightening biases in anticipation of future policy actions. Another example is the Fed’s repeated statement that it will keep interest rates low for a protracted period. And some central banks—e.g., Sveriges Riksbank, Norges Bank—go even further and publish a projected path for future interest rates.

43. Consistent communication in these areas allows the public to learn over time about the reaction function of the central bank. This makes monetary policy more predictable, and it can thereby help its effectiveness, including by enhancing the credibility of the inflation target and by anchoring inflation expectations.

Communication by the Central Bank of Russia

44. In recent years, the CBR has made important progress in its communication. The annually adopted and published monetary policy guidelines (with a 3-year horizon) give an adequate sense of the CBR’s inflation objectives. The monthly inflation reports analyze elaborately past and current economic conditions. And the monthly post policy meeting statements provide an explanation of policy decisions and reveal, to some extent, information about the outlook for future policy. The latter statements have recently become more sophisticated by including references to the cyclical position of the economy such as capacity utilization and the output gap.

45. Still, considerable room for improvement remains. Four areas for improvement are of particular relevance.

  • Inflation projections. Thus far the CBR’s inflation reports have been largely backward looking. While the reports are thus useful for the public to understand past conditions and policy actions, they provide little guidance with respect to future conditions and policies. For this purpose, it is important that the CBR follows through with its plans to add a forward-looking section to the inflation reports. Eventually, this forward looking section should also include inflation projections over a reasonable horizon. Such projections would provide important information to the public that would allow it to anticipate and understand CBR policies and make monetary policy more predictable. Such predictability, in turn, might help further insulate monetary policy from political influences, thereby strengthening the CBR’s de facto independence.

  • Minutes. To reinforce and support the policy explanations provided in the monthly policy statements and to provide additional information on the decision making process, the CBR could also usefully start publishing minutes of past policy meetings of its Board. This would also enhance the CBR’s accountability to the general public. At the start, minutes could be published with a relatively long lag such as to minimize potential sensitivities. Going forward the CBR could experiment with shorter lags, depending on experience and usefulness (the Fed, for example, gradually stepped up the speed of the release of its FOMC meeting minutes, and currently makes them available before the subsequent meeting).

  • “Noise reduction.” For monetary policy communication to be effective, it is important that the various different communications in this area are mutually consistent so that they help guide, and not confuse, the public. In this context, it is important that other government agencies such as the ministry of finance and the ministry of economy respect the CBR’s mandate in the area of monetary policy. This implies that generally related communication would be the exclusive domain of the CBR and that any communications by the MoF or MoE on the monetary policy stance or liquidity situation in the banking system will need to be closely coordinated with the CBR.

1

Prepared by Simon Gray.

2

Liquidity is used here to mean commercial bank ruble current account balances at the CBR.

3

The central bank’s refinancing rate normally sets a ceiling to overnight interbank rates, but only if the bank which is short of liquidity holds eligible collateral. Sometimes banks are reluctant to use a standing facility if there is a perceived stigma associated with its use. It is therefore not uncommon for markets to see overnight rates spike above the standing credit facility rate.

4

The ECB set the minimum bid rate for its short-term open market lending operations.

5

Sometimes referred to as a refinancing rate, or Lombard rate, or Discount Window rate.

6

Historically, a number of Advanced Economy central banks operated this way, announcing a fixed rate for the standing credit facility, but operating—often in a nontransparent manner—in the secondary market for short-term trade bills, in order to guide market rates towards the desired level.

7

That said, an increasing number of central banks, perhaps because of difficulties in managing liquidity via OMO, offer a deposit standing facility to prevent an excess of reserve balances pushing interest rates too low. This matters both for Inflation Targeting and Exchange Rate Targeting. Where the exchange rate is the main target of monetary policy, and particularly where this takes the form of a hard peg, short-term interest rates are more often market-determined, since the central bank cannot fix both the external price of money (the exchange rate) and the internal price (the short-term interest rate) unless it imposes effective capital controls.

8

Many smaller banks were reluctant to rely on the interbank market, fearing that the difficulty of coping with the short-term volatility would leave them exposed to potential losses.

9

The new system included averaging of voluntary, contractual reserve balances over a 4–5 week period (the period between MPC meetings), weekly short-term liquidity OMO, and provisions to minimize liquidity risk on the final day of the reserve maintenance period.

10

Some central banks will allow market rates to move to the ceiling in times of capital outflows, as a form of automatic stabilizer.

11

The overnight market rate used here is the Moscow Interbank Average Credit Rate, known as MIACR. MIACR has been around the middle of the corridor in January–February 2009 when use of the repo OMO was also substantial, but for a briefer period.

12

A Working Group on Operating Procedure of Monetary Policy, constituted in July 2010, published its report in March 2011. The May 3, 2011 Monetary Policy Statement 2011–12 of the RBI details changes introduced.

13

See Croatian National Bank Annual Report 2005, Chapter 2. “Open market operations were introduced for the purpose of promoting monetary management and establishing a more active role of the Croatian National Bank in banking system liquidity management. Over a short-term, the objective of open market operations was to achieve stabilization of the overnight interest rate and create a reference interest rate on the money market. Over a longer term, the aim of monetary policy is to establish a transmission mechanism that involves the operation of an interest rate channel. With the introduction of open market operations, the central bank redefined its existing monetary policy instruments and introduced new ones.”

14

The Bank of England, pre-crisis, narrowed the corridor on the last day of the reserve maintenance period: in the system operational from May 2006 until the financial crisis (when the BoE has effectively ended short-term operations), the SF corridor was narrowed from +/-100bp during the RMP to +/-25bp on the last day of the RMP. Theory (the so-called ‘Martingale property’) suggests that if interbank rates can be tightly anchored on the final day of the RMP, then inter-termporal arbitrage will operate to keep overnight rates in line with the policy rates on other days of the RMP.

15

For example, an overnight trade yielding a gain of 25bp on US$1 million equates to a gain of US$6.85.

16

Trading costs on platforms such as MICEX will tend to be lower, and so allow for smaller deals.

17

The U. S. Fed was not by law permitted to pay remuneration of reserves balances until October 2008, so did not operate a corridor system until that point.

18

As an exceptional measure, the ECB operated a narrow corridor when the euro was introduced. Between January 4–21, 1999, a narrow corridor of 50 basis points was applied between the interest rates for the marginal lending facility and the deposit facility, aimed at facilitating the transition to the new regime.

19

Prepared by David Hofman.

20

For a useful overview of the history of central bank communication and a broad discussion of relevant issues see Blinder et al. (2008) Central Bank Communication and Monetary Policy: A Survey of Theory and Evidence, NBER Working Paper No. 13932, and Woodford (2005) Central Bank Communication and Policy Effectiveness, NBER Working Paper No. 11898.

21

Some evidence for the assumption that central banks possess information superior to that of others can be found, e.g., in Romer and Romer (2000), Federal Reserve Information and the Behavior of Interest Rates, American Economic Review, 90(3):pp. 492–457.

Russian Federation: Selected Issues
Author: International Monetary Fund