‘Structural Damage’: New Shocks and Central Bank Policy

Monetary policy is increasingly shaped by large-scale disruptions – from the coronavirus pandemic and the energy crisis to geopolitical conflict, trade wars and economic fragmentation in recent years. On 14 April, participants in an online panel at New Economic School (NES) discussed how central banks are addressing these challenges and rising uncertainty – and whether they are prepared for an economy where supply shocks are becoming more frequent. The discussion (link in Russian) was held as part of the Educational Days in memory of NES co-founder Gur Ofer.

Econs presents excerpts from the conversation, which brought together Alexey Zabotkin, Deputy Governor of the Bank of Russia, Oleg Shibanov, Professor of Finance at NES, and Ksenia Yudaeva, Executive Director for Russia at the IMF.

Crises: a ‘new normal’?

Countries’ monetary policy has become increasingly dependent on external disruptions. As shown by a recent study by MIT professor Kristin Forbes and her co-authors, since the early 2020s, half of all interest rate changes in advanced economies have been driven by global shocks – more than twice the share observed at the end of the 20th century. The discussion was framed by the moderator, Philip Sterkin, Editor-in-Chief of the NES educational portal GURU, who posed the following questions: have permanent shocks become a ‘new normal’, or is this a temporary period of frequent disruptions? Has their nature changed, or are these ‘old’ shocks in ‘new packaging’? Has a more isolated Russian economy become less vulnerable to external shocks, or has greater dependence on a few trading partners increased its vulnerability?

Ksenia Yudaeva:
– From a theoretical standpoint, the set of shocks that economies face has not changed. They remain the same demand shocks and supply shocks – that include external shocks, such as oil price shocks for Russia – along with shocks to financial stability that affect financial markets and to which monetary policy must also respond. However, the context has certainly changed significantly. The global economy and financial markets are constantly evolving. For example, whereas most countries, including Russia, entered the Covid crisis of 2020 with fairly low inflation, many countries now retain a strong memory of the inflation surge in 2022–2023, and in some cases, in subsequent years as well. Similarly, emerging economies have historically faced virtually the entire range of shocks, while advanced economies mainly encountered demand shocks alone – but today, supply shocks have become more frequent across both groups of countries. All of this affects the type of policy that a central bank, in particular, should pursue.

Alexey Zabotkin:
– Strictly speaking, Kristin Forbes’ conclusions are exactly the result one would expect in a more globalised economy. Even allowing for some retreat from globalisation in recent years, the world remains far more interconnected economically than it was in the 1980s, or even the 1990s. In this environment, any individual economy will feel the impact of external shocks more strongly than if it was less integrated into global flows of goods, services, production factors and finance. This applies equally to both advanced and emerging markets. However, for emerging markets, external shocks have always been at least as significant a source of macro volatility as their own domestic dynamics – and often more so. Whether vulnerability to these shocks has risen or fallen is always a matter of domestic macroeconomic policy.

Oleg Shibanov:
– Shocks existed before, but their size, or magnitude, may differ from what has been observed historically. The fact that these shocks are occurring so frequently also differs from the macroeconomic environment we knew in the second half of the 20th century. New elements include the fragmentation of global trade and [US President Donald] Trump’s tariffs. If the tariffs are removed and we return to the position as of 2024, then one could probably argue that this particular shock has not proved to be entirely new after all. We have long known that there is a wave-like pattern over time, with external shocks making a larger contribution in some periods and a smaller one in others. The 2020–2024 period turned out to be highly specific, with numerous global shocks, and it is not surprising that Kristin Forbes found a large contribution from external shocks over this period. However, I would be cautious about drawing the conclusion that global shocks will always dominate the impact on individual economies and their inflation from now on.

Long-term effects

Oleg Shibanov:
– The Russian economy’s dependance on the global economy remains largely in the form of dependance on commodity markets, via the prices and volumes of raw materials that Russia is able to supply. The global economy may now influence the Russian economy to a slightly lesser degree than was the case before 2014. In this sense, although the Russian economy remains dependent on the global economy through commodity markets, it has begun to focus far more on domestic growth and on what is happening to household consumption.

Alexey Zabotkin:
– It seems to me that the Russian economy has withstood the challenges it has faced over the past five to six years with considerable resilience. As of the end of 2025, we had record-low unemployment, while the ruble exchange rate was the same as it was at the end of 2021, despite significant exchange rate volatility over this period. In fact, contrary to all fears, no systemic weakening of the ruble occurred in 2022–2025. We are gradually bringing high inflation under control: annual inflation rose to 10% early last year and currently stands at 6%. Moreover, given the policy stance in place, we expect to ensure its return to the 4% target as early as the second half of this year in terms of current price growth rates, and next year – in terms of year-on-year rates.

Preserving macro stability and preventing future vulnerabilities is a direct function of the quality and consistency of the macroeconomic policy pursued. It is worth stressing that the Russian economy has withstood the period of upheaval from Covid onwards noticeably better than many had expected. This resilience is due to the macroeconomic policy, financial stability policy and banking sector resolution implemented since 2013. These laid the solid foundation on which the economy was able to withstand the shocks. I would therefore certainly not talk up the vulnerability. To use a metaphor, if you live in an area where strong winds blow frequently and you have a house of brick, a passing hurricane is no reason at all to go out into an open field and build yourself a house of straw. It is better to remain in the same reliable brick house that has already served you well.

Ksenia Yudaeva:
– I think it would be interesting to discuss how many prominent economists characterise the current situation in the global economy, and what the potential consequences might be, including for Russia. What is happening now is described by Gita Gopinath (Chief Economist and First Deputy Managing Director of the IMF until 2025, currently Professor of Economics at Harvard University – Econs’ note) as structural damage [that accumulates over time and ‘materialises slowly and always too late to fix’].

This applies, for example, to the tariff policy of the US administration. Yes, some tariffs have been ‘rolled back’, but on the whole, the world has started to get used to the idea that ‘this was possible’, and uncertainty has risen sharply. The current conflict is only adding to that uncertainty. On top of this, there is the ongoing fragmentation of the global economy. All of this, of course, may have long-term adverse effects.

An interesting example here is Brexit – the United Kingdom’s exit from the EU following the decision taken in 2016. Many British people genuinely believed that this would be good for the country, while economists warned at the time that it was a poor decision. Initially, no negative effect was felt: in the first two years, investment grew very rapidly and economic growth was fairly brisk. However, over a ten-year horizon, UK GDP turned out to be roughly 6–8% lower than it would have been in the absence of Brexit. In other words, this is broadly the price that the UK has had to pay for Brexit – for the rise in uncertainty and the altered terms of engagement with surrounding markets. This is a highly instructive example of what may await us and just how persistent and severe these supply shocks can be. The core problem is that central banks simply cannot offset this. Attempting to do so would mean higher inflation, a breach of their mandate and the need for an even more aggressive response later.

Supply shocks and inflation expectations

Ksenia Yudaeva:
– A rule of thumb that central banks often apply is: if a supply shock occurs, but inflation expectations are very well anchored, then it may be possible to wait it out, especially if the shock is temporary. During the inflationary shock of 2022–2023, advanced economies did in fact try to pursue a ‘wait-and-see’ approach, and in many of them, inflation rose quite substantially, requiring a fairly aggressive response. All of this left a rather serious negative legacy: people remember that inflation jumped, and one can no longer speak of inflation expectations being as firmly anchored as they once were. It is therefore essential to monitor inflation expectations and to respond with the degree of tightness that is necessary for the particular country in question.

There is another important point here: we keep talking about inflation, whereas people very often think in terms of prices. If inflation has jumped sharply, then even after it has been brought under control, prices will not return to their previous level [i.e. prices have risen and remain elevated]. This has a considerable impact both on people’s perception of the situation and on their inflation expectations.

Alexey Zabotkin:
– If there are grounds to believe that supply-side shocks over the next N years – regardless of whether N is small or large – will be predominantly pro-inflationary, then the central bank must build this into its policy. In particular, this would mean that inflation should be kept somewhat below target during calm periods, in order for it to remain at target over the long run once these shocks are taken into account. The average outcome across calm periods and periods of pro-inflationary shocks would then be inflation at the target level. This is precisely how inflation expectations become anchored. NES Professor Valery Charnavoki makes this point in a recent paper (link in Russian).

This in no way implies that central bank policy should be unjustifiably conservative. It means that a well-calibrated policy, appropriate to the circumstances, must explicitly take into account the fact that the right tail of the distribution of future inflation and future inflationary shocks is noticeably heavier, and that this distribution is significantly asymmetric. (The ‘right tail’ is the region of values well above the average; ‘heavier’ means that the probability of such high values is noticeably greater than usual. In other words, the risks of an inflationary upsurge are far higher than the risks of deflation. – Econs’ note.) In a sense, this picture stands in stark contrast to the one that characterised the world economy in the 1990s, when the forces of globalisation shifted this distribution more towards the disinflationary [left] tail.

We invest considerable resources in various communication formats, including direct engagement with the public via social media, educational materials, financial literacy programmes, etc. Ultimately, however, people believe actual outcomes. Inflation expectations will be low only when people feel that price growth is low. Therefore, the only way to lower inflation expectations materially and sustainably is to deliver low inflation.

Oleg Shibanov:
– The literature on supply shocks and how central banks should respond to them is developing rapidly. We are moving towards frameworks that increasingly acknowledge that ignoring these shocks will not be an option if they are permanent in nature and occur regularly. Central banks will have to respond to them more actively, even though these shocks are somewhat less susceptible to policy pressure: it is much easier to influence demand than supply. Nevertheless, central banks must still use interest rates to try to limit the impact of supply shocks on inflation over the medium term.

Central bank independence and mandate

Ksenia Yudaeva:
– Persistent shocks may cause inflation expectations to remain elevated all the time. That does not mean, however, that central banks should not fight this. The alternative is even worse: severe stagflation, when economic growth remains sluggish while inflation keeps rising. It is easy to let the genie out of the bottle; putting it back in will be hard.

A very serious threat for central banks is pressure from fiscal policy, when the budget deficit and public debt become very large and the temptation may grow to finance them from monetary sources as market sources diminish. Fiscal dominance is the main problem for central bank independence, which is precisely why this independence must be strengthened.

Oleg Shibanov:
– If the central bank continues to operate in line with its mandate of maintaining price and financial stability, then it will always respond so as to fulfil its mandate, whatever the Ministry of Finance does. In virtually any autobiography or book about US central bankers, one can find dozens of pages devoted to how presidents telephoned the central bank and said ‘do this’. Those central bankers who respond to such calls respectfully but then do what is right are remembered as people who managed to balance the economy appropriately. The central bankers of the 1970s, by contrast, are remembered as people who succumbed to pressure and ultimately allowed inflation to surge. Therefore, central bank independence must be constantly monitored, supported and upheld. It is an exceptionally important institution.

Alexey Zabotkin:
– There is a fine Russian proverb on this point, and I imagine other languages have equivalents: ‘If you chase two rabbits, you will catch neither’. Trying to broaden the central bank’s mandate in pursuit of additional objectives beyond price and financial stability will undermine (link in Russian) its ability to achieve those very goals. Price stability – low inflation and a predictable purchasing power of the national currency – is essential for ensuring predictable economic conditions for all economic agents: households, businesses, the state and the budget. This makes it absolutely critical. It is one of the top-priority tasks of economic policy, entrusted to the central bank.