All bets are off, no more bets: unyielding Elvira Nabiullina and the ghosts of the liquidity trap
The Central Bank of Russia is not going to reduce the key rate significantly. Or to reduce it at all
In anticipation of the meeting of the board of directors of the Bank of Russia today, on 10 June, the economic observer of Realnoe Vremya newspaper Albert Bikbov has studied the statistics and has come to the conclusion: they are not going to reduce the key rate (or will reduce it insignificantly). On the threshold there has loomed up very serious macroeconomic problem – a surplus of liquidity, which can lead to the so-called 'liquidity trap' when money infusions into the economy may stop working.
Medvedev is wrong: there are money but not where they should be
Rosstat reported that for the week from 31 May to 6 June the consumer prices for goods and services in Russia did not change, that is, the weekly inflation rate was zero for the first time since August of 2014. Inflation is falling in the eyes: in May of 2016, it remained at the level of April and totaled 7.3% against 7.3% in March, 8.1% in February and 9.8% in January.
One week of zero inflation – it is not the whole month yet, but the trend is clear. Due to tough monetary policy, over the past months there was a steady decline in the growth rate of prices. In comparison with last year the pace has dropped twofold.
We should not forget that central banks in formulating their decisions are guided by the extent of inflationary expectations of the population (revealed during the surveys). What's the point if on paper the inflation is low but people have an opposite opinion. But everything is good with the inflation expectations: according to the estimates of the Bank of Russia, based on the data of the survey 'inFOM', in April 2016, the inflation expectations for the next 12 months slightly decreased. According to the April survey, the assessments with the using of normal and uniform distributions of expectations about the future inflation accounted for 7.2% (against 7.4% in March).
Meanwhile, the Board of Directors of the Bank of Russia on 29 April at the second meeting in 2016 decided to keep the key rate at 11%. Moreover, on Monday, 30 May, the head of the Bank of Russia Elvira Nabiullina said:
'Our assessment shows that now the sharp rate reduction will not lead to a significant economic growth, but can only provoke a new surge of inflation.'
That means that there is no hope for significant reduction of the key rate at the scheduled on 10 June of 2016 meeting of the Board of Directors of the Bank of Russia. All the consensus forecasts of analysts give almost similar results: a half of the experts think that the rate will not be lowered, the other half – the reduction will be, but very small (from 11% to 10.5%).
There are several factors that play in favour of a small rate cut: a fatigue of the society from withholding of the key rate at the same high level for a long time (8 months in a row), as well as a favorable moment connected with the weakening of the dollar and the low probability of a rate increase by the FED.
In the regime of inflation targeting, the main influence instrument of Central Bank on the economy is the interest rate. The Central Bank conducts its operations on provision and withdrawal of liquidity so that the short-term risk-free rate of money market was close to the key rate or at least was in the interest corridor of plus or minus 1% of the key rate.
If you look the data of the money market, then, for example, the rates of interbank loans in the banking system of Russia today are fairly close to the official key rate.
Besides, the amount of money in the economy is growing. Look at the dynamics of the money supply (M2 aggregate):
Hello, the surplus liquidity!
In other words, there are so much money in the banking system that you can even 'drown'. Those who follow the balance of the Central Bank and its operations may have noticed that in recent months the volume of transactions of the Central Bank on provision of liquidity has significantly declined. The auctions on the provision of loans secured by loan requirements almost do not take place, and the volume of loans is gradually eroding. The volume of liquidity provided by the REPO auctions has also significantly decreased. For example, on 22 December of 2014, the debt of banks reached a historical high of 3.8 trillion rubles, and by 7 June 2016, the debt was reduced to 180 billion rubles (!). Money from the Central Bank are not needed by the bankers.
At the same time, there is a process of growth of deposits in the Bank of Russia, which has increased twofold in comparison with level of last year.
In other words, there is a gradual shift from the structural deficit to structural surplus of liquidity. More and more we hear that interest rates on consumer and some types of corporate loans returned to the level of the first half of 2014 (the period before the fall in oil prices)
The structural surplus of liquidity – this is when the Central Bank cannot provide liquidity to the banking system, because banks have no demand for loans. In such cases, the reduction of the key rate of the Central Bank has no effect: banks do not take money, they do not know what to do with their own money. But the demand for loans in the frozen economy is low yet – that is why the banks put money on deposits in the Central Bank. In such conditions, there is no difference whether they reduce the key rate at which banks get loans or do not reduce. At such rate, in a couple of months we will come to the situation when the main tool for managing of interest rates of the money market will be not the repo auctions and loans secured by non-marketable security, but deposit auctions and bonds of the Bank of Russia. The banks will compete for the right to put money in the Central Bank. Accordingly, the interest rates on deposits established by the Bank of Russia, or the rates on the placed bonds of the Bank of Russia will be those markers of monetary policy. It is through operations on purchase and sale of the bonds and through the taking and closure of deposits the Central Bank of Russia will supply the economy with money.
The surplus liquidity in the banking sector exists in Poland, South Korea, Czech Republic, Israel and Chile – these states successfully cope with this problem, there is nothing terrible there.
But in Russia we have everything, of course, different: the reason for the formation of 'overhang' of surplus liquidity – the reduction of the solvent demand on money resources. The strengthening of the ruble caused by the rising oil prices prevents the banks to direct liquidity to the foreign exchange market. The stock market is also not attractive enough for the banks. The banks are becoming uninterested in money.
On the threshold of the horrible trap
Ahead is the terrible threat: if to put too much emphasis on the macroeconomic stabilization, by twisting the screws by tight budgetary and monetary policy, thus killing inflation, then we can end up to zero interest rates. Then, the direct money stimulation of the economy will give nothing: money won't be needed, there will not be investments, and people simply will no longer spend money as before, and will move on a savings type of behavior. And we already see the first signs of it.
We will remind you once again a classic case, how already in the early 1990s one country, Japan, turned out to be in the worst economic trap – 'the liquidity trap'. Monetary stimulus became just useless. It took the 1990s and the beginning of the 2000s, using Keynesian fiscal stimulus, to get out of this trap: to build roads and bridges, regardless of whether the country needed them or not. Besides, the growth of China helped, which used Japanese components in their products. We managed only by the mid-2000s to reach 2% economic growth. But the crisis of 2008-2009 dropped the Japanese economy very hard. So there is every indication that almost 25 years for Japan are lost. A terrible number. But they entered these 'lost decades' being one of the richest countries in the world, and it affected little on their standard of living. What cannot be said about our country!
The main thing for our financial authorities now – it is not to stimulate the economy through money infusions but to create the conditions for the economy growth, in order there would be demand for loans from the private sector, in other words, to transit from 'the economy of demand' to' the economy of supply'.