Ksenia Yudaeva, First Deputy Governor of the Bank of Russia, on inflation, stagflation and when sustainability is more important than efficiency.
In December 2022, in honor of its 30th anniversary, the New Economic School (NES) held NES Educational Days in memory of Gur Ofer, the founder of NES and an outstanding academic and economist. The Educational Days included several online and offline discussions. NES alumnus Ksenia Yudaeva, First Deputy Governor of the Bank of Russia, took part in the discussion dedicated to the global economy.
Over the past 100 years, global inflation has switched from low- to high-inflation regime three times: after both world wars and in the 1970s. Is a decade of Great Inflation after a decade of low rates facing us again?
– I think that here two different concepts slightly intersect. One is inflationary expectations. This is what I now understand more and more: if you truly have low inflation, a low inflation target, low inflation expectations, then they are stable. People just don't remember what inflation is, they don't even really know what it is, and they don't worry about it.
In the Soviet Union, inflation was low. There, however, the deficit was growing all the time, but inflation, in principle, was low. Sometimes it was decided to increase the price of vodka several times at once, but in general [with inflation] everything was normal. And I remember well when, 10 years ago, I was told that Russians were incapable of long-term instruments, long-term investments – I looked, there were younger people in the audience and roughly my peers, and I asked all my peers who had life insurance before the age of 18 (there was such a product). Everybody had it! Some for 500 rubles, some for a thousand, everyone, every last person had such insurance! It was the done thing. In kindergarten your parents insured you and saved up this money until you were 18. I couldn't use the money because we went into a high-inflation regime, and since then, the credibility of these kinds of tools has been somewhat eroded. But in general it existed. That's why inflationary expectations are not the kind of thing that a person is born with. They are related to experience, to the assessment of the situation, to the assessment of politics, but in general, in reality, if inflation is low, then so are inflationary expectations.
This is what we have seen throughout the so-called Western world and, generally, in a large swathe of the East over many recent years. But not in Russia, in Russia we have actually been living with high inflation for 30 years, in recent years we have reduced it, but by the way people perceive inflation, how they react to it, we, of course, understand that inflation is still perceived as rather high, as a rather volatile factor. Low inflation seems to be perceived as more of an accident. In practice, this means that people always pay attention to it, always come up with some protective strategies to protect themselves from this inflation. In particular, they are not ready to buy long-term products, invest in them, they want more short-term control. Two [different] regimes indeed.
And in the situation in which everyone found themselves this year... So how does it differ from, say, last year? Last year – I remember well when we still went everywhere, you'd come to the G20, to the IMF, and they'd say, "Well, this is a temporary increase in prices." And I remember being looked at in disbelief when we said, "No, no, no, inflation is a threat, you have to respond, you have to raise the interest rates," and so on. This year the situation has changed, because it turns out that even if this [acceleration of inflation] is temporary, it is still taking a long time and is turning out to be quite volatile at the same time, and there are risks of transition to that very other regime. Those who did not pay attention to inflation when it was between 0 and 2% are somewhat paying attention now it has suddenly become 8–10%, and may begin to turn to strategies aimed at consistent protection of themselves from inflation, which will thus fix this high-inflation regime and make it steady.
That is why this year we see drastic changes in policies, sharp changes in rhetoric. I think that's what's keeping the world from slipping into that other state. Everyone clearly remembers the experience of the seventies. In fact, there was a more complicated situation then, the ground had been prepared for it all, if you take America, by the Vietnam War (since the mid-1960s in the US spending on the Vietnam War and President Lyndon Johnson's "Great Society" social reform program had been growing, for the financing of which the Fed had been keeping interest rates low – Econs note); and from an academic point of view, probably, there were the Keynesian notions that the Phillips curve was very stable, and therefore we would have an endless trade-off between inflation and unemployment (the Phillips curve shows the relationship between inflation and unemployment: the higher the inflation, the lower the unemployment – and vice versa, a decrease in inflation is associated with an increase in unemployment. However, it was later proven that this relationship doesn't always hold – Econs note). And on top of the oil price shock, the whole situation shifted, not just into a state of high, but of constantly increasing, inflation.
I have a picture that I sometimes show when I give lectures: there you can see how the spiral is twisting. With the same unemployment, or even rising unemployment, inflation also constantly rises, and so we get stagflation. I think that everyone remembers that, and I think that, of course, everyone is now making a significant effort not to fall into this situation.
Do economists' perceptions of economic policy priorities change due to the increasing role of the state in the economy and the dominance of security over efficiency?
– I would like to speak a little not just as the devil's advocate, but to talk a bit about that grain of rationality which is to some extent present in politics now.
Certainly, the pendulum first swung to the right, and has now swung back to the left, and, probably, the people here in this audience will live to see it swing back in the opposite direction again, but nevertheless a certain rational element in this [current rebound] exists, indeed it appeared during the Covid pandemic.
And for me as a macroeconomist, as well as a person who is engaged in monetary policy and especially financial stability, this is clearly visible, because there are contradictions between short-term efficiency and long-term sustainability. These are very understandable contradictions in economics. In macroeconomics, we talk about this all the time. If you want to maximize output this year, then expect a recession next year, because you will have used up all your resources, inflation will begin, problems will begin, you will fall into a recession. And in principle, for long-term development it is much more appropriate to have smoother development. In fact, the task of monetary policy – and in many ways fiscal policy – is to ensure smoother development with small fluctuations around the trendline. Mitigating fluctuations around the trendline is, strictly speaking, what such policy usually does.
And the world faced exactly that problem especially brightly during the Covid pandemic, when it became clear that, yes, to a huge degree over the past 20–30 years of globalization the world has taken advantage of the decrease in the cost of transportation, the increase in the efficiency of logistics and so on, invented all these just-in-time concepts (just-in-time is a concept of efficient production management which have come to dominate in recent decades, assuming, in particular, full capacity utilization and support of warehouse stocks only at the level necessary for immediate dispatch to customers. – Econs note), the locations of a production chain in a large number of countries, be it a cell phone or a Boeing plane, cross borders, I guess, 400 times for the various parts which make it up, before the final product is wrought. All of this is good, but it all turned out to be very unstable during the Covid pandemic, when it turned out that some things, for example, chips, are produced in one country in the world, and if this country faces some problem, no matter what, for example, with Covid, the rest of the world actually runs the risk that a very wide range of goods cannot be produced.
Therefore, a more distributed system, less efficient in the short term, but which allows diversification of sources, proves to be more resilient to such shocks. There was even an expression instead of just-in-time – just-in-case (the complete opposite of just-in-time: it implies the availability of spare capacity and large warehouse stocks in case of interruptions in deliveries or urgent orders. This principle is considered inefficient, but a large "liability" turns into an asset in moments of shock. – Econs note).
With just-in-case we create reserves, create additional backup production chains, hedge against different risks and so on. This idea appeared, and of course, again, as a person who deals with financial stability, it is, in principle, quite close to my heart, because all regulation of the financial sector, especially macroprudential regulation, is just-in-case. With just-in-case a bubble is formed in the market, and we need to create an additional buffer so that when this bubble begins to deflate, it does minimal damage to everything around it and all losses are absorbed by this buffer. With just-in-case even if the market runs out of liquidity, there should be either liquidity buffers or the central bank's lender-of-last-resort instruments that allow the market to function and prevent a small liquidity crisis in one small part of the market from degenerating into a large payment crisis throughout the entire economy.