Dilemma or Trilemma?
Yesterday, Interfax released an interview[1] with First Deputy Prime Minister Andrei Belousov, where, among other things, the official said that the optimal dollar exchange rate is in the range of 70-80 rubles. In addition, Belousov noted that under the current conditions, many mechanisms for managing the economy in Russia have broken down (we are talking primarily about the budget rule), so rethinking is needed. Further, the Deputy Prime Minister said that it is necessary to move towards the optimal value of the exchange rate as soon as possible. As a result, all these passages in the interview received the following interpretation in the media: let's target not only inflation, but also the exchange rate ("we have space for the joint development [of the Government and the Central Bank] of a new mechanism in which there is a place for the equilibrium exchange rate").
Immediately in the media there were quotes from representatives of the Bank of Russia about why this idea is bad:
- E. Nabiullina: "The position of the Central Bank is that we are targeting inflation, but we are not targeting the exchange rate. The ruble should remain floating"
- A. Zabotkin: “We must understand that any ideas related to rate targeting will inevitably, if implemented, lead to a decrease in the efficiency and loss of sovereignty of economic policy. If a fixed exchange rate is determined by some predetermined range, we are essentially we refuse to pursue an independent monetary policy in favor of the country to whose currency we tie our exchange rate"
In short, the objections from the side of the Central Bank boil down to the fact that either inflation or the exchange rate can be controlled. More specifically, the trilemma of international finance (only 2 out of 3 good goals can be achieved: independent monetary policy, free movement of capital, and a fixed exchange rate). I wrote a little more about the trilemma here.
However, I would like to point out that today there is an opinion among economists that in reality we should not talk about a trilemma, but about a dilemma: you cannot support an independent monetary policy and free movement of capital at the same time.
In particular, this is stated in the article Dilemma not Trilemma: The global financial cycle and monetary policy independence[2] by E. Rey. If you try to reduce everything to something simple, it will come out something like this:
- 1. Capital flows are highly volatile and pro-cyclical (when growth increases, when recession decreases).
- 2. At the same time, capital flows depend largely on the monetary policy of developed countries, which in turn is closely related to their state of the economy.
- 3. If developed country monetary policy tightens sharply or developed economies go into recession, the countries that have borrowed are in trouble: debt rises to unsustainable levels.
- 4. The growth of external debt greatly complicates the implementation of an independent monetary policy, because it becomes more difficult to service debts, which affects the exchange rate (regardless of the exchange rate regime), the weakening of which becomes a pro-inflationary factor - the national Central Bank has to tighten monetary conditions.
- 5. It turns out that without any kind of capital controls, developing countries cannot pursue independent monetary policy in the full sense.
However, this problem does not at all mean that the Central Bank needs to have not only an inflation target, but also an exchange rate target. Rather, it is about the fact that some measures of capital control are necessary to ensure that the country does not have problems with unmanaged debt, which not only makes independent monetary policy more difficult, but also, due to increased instability, hurts long-term growth prospects.
The graph clearly shows the procyclicality of credit dynamics (the recession during the 2008-2009 crisis hit capital flows hard).
Well, briefly about Russia. We have low external debt, we are weakly dependent on capital flows, and even tightening of monetary policy conditions in developed countries is unlikely to affect the ability of the Central Bank to pursue an independent monetary policy. Especially in conditions of such financial constraints. My hypothesis is that the dilemma (rather than the trilemma) applies more to countries with weak financial markets and low savings rates (Argentina, Turkey, for example).
Grigory Bazhenov 2022-06-21
