In the years preceding the onset of the global financial crisis, the Central Bank of Russia (CBR) had two goals: to reduce inflation and limit the real appreciation of the rouble. Given the strength of Russia’s balance of payments during the ten years through the first half of 2008, the de facto tight management of the nominal exchange rate resulted in large interventions which were only partially sterilised. As a result, inflation remained persistently high. During the global financial crisis in 2008-09 Russia’s monetary policy was initially constrained by a large degree of private debt dollarisation. After a gradual adjustment of the exchange rate to the new oil price environment which was costly due to reserve losses, the CBR started to lower interest rates and to allow for a somewhat higher degree of exchange rate flexibility. Looking ahead, even greater exchange rate flexibility should be permitted since (i) commodity exporting countries can successfully run inflation targeting and (ii) we find that exchange rate pass-through has been limited and asymmetric and can be taken into account under inflation targeting. Preparations for inflation targeting should focus on a commitment to price stability as the primary goal of monetary policy. At the same time the authorities should enhance their understanding of how monetary developments affect inflation and financial stability and accelerate financial sector reforms aimed at financial deepening.
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