Anatomy of the Russian Inflation
by Paula De Masi and Vincent Koen

After the many decades of So- viet rule, high open inflation ap peared in Russia in 1991, following the introduction in April 1991 of partial price reforms and the de facto loosening of price controls. A comprehensive price liberalization followed in January 1992, and monthly inflation rates remained in the double digits for most of the next three years. By the end of 1994 consumer prices had increased nearly 2,000 times compared to December 1990. Such a huge price increase raises a number of interrelated questions:

•To what extent have relative prices shifted during the transition?

•Are prices moving more in lockstep as the Russian public learns to live

with high inflation?

•Have geographical price differences become wider or narrower?

•Have prices overall moved closer to levels in the industrialized countries?

•What are the policy implications of further convergence of Russian and Western price levels?

These questions have thus far received little attention, notwithstanding their important policy consequences.

As Russia's old, distorted system of controlled prices was liberalized, individual prices started to adjust at different speeds, which brought major shifts in relative prices. By late 1992 most relative price changes had taken place, especially for nonfood items. Individual food prices, however, kept changing relative to each other, even during 1993, as food subsidies were adjusted.

Another way to look at relative price changes is to contrast the price behavior of goods versus services. In April 1991 and January 1992 service prices rose much less than goods prices (see figure 1), but then service prices started to shoot up, and by late 1994 reached a level that exceeded five times the December 1990 level. In part, this reflects the commercialization of a number of services such as child and health care, previously provided for a nominal fee. Also, prices had to be increased from a very low base to catch up with costs. In the case of housing, for example, rents rose by almost 500 times between late 1992 and late 1994 (compared with a 30-fold increase in the overall consumer price index). A similar "U-curve" pattern has been observed in many other countries of the former Soviet Union.

Relative price movements can also be measured by comparing inflation rates for a large number of individual goods. (Figure 2 shows how the variability of relative prices—measured as a weighted variance of item specific inflation rates—evolved, and relates this to overall inflation.) Relative price variability remained very high throughout 1992-93 in comparison with market economies (in 1993, on average, it exceeded more than 20 times the variability in the United States and France). But, by 1993 it had substantially declined compared with 1992, indicating that most changes in relative prices had occurred by that time, and price setting became increasingly synchronized for individual goods, as producers and consumers learned to live with chronic high inflation.

Relative price variability and inflation clearly moved in tandem in 1992-93.In the longer run, however, the relationship between the two may weaken, as price setters increasingly coordinate price adjustments based on some visible and unambiguous signal such as the ruble exchange rate. An excerpt from a recent article in the Moscow-based Kommersant Daily (February 3, 1995) indicates how closely the exchange rate is now followed: "Only about half an hour will pass after the beginning of tenders and thousands of pagers will beep and thousands of telephones will ring announcing the news about the new exchange rate of the dollar. A little more time will pass and the money-changing offices will post new figures on their doors and the announcers on practically all the television and radio stations will interrupt in order to expressively read a couple of four-digit figures...."

Prices and nominal incomes have traditionally varied widely in Russia's different regions. (The country is vast, and its climate is harsh, making for considerable distribution costs.) But as uncertainty about new relative prices waned, and local subsidies and other local price controls measures lost their earlier importance, the geographical price differences for both food and nonfood goods narrowed—a sign of market integration. (The disparity was initially larger for food than for nonfood goods, probably because of extensive food subsidization and internal trade barriers in agriculture.) Nonetheless, the degree of regional price dispersion is still high, compared for example, with Canada, which, among the industrialized countries comes closest to matching Russia's climate and distances (see table below).

In general, prices are typically lower in poor countries, particularly for nontradable services (such as haircuts). Given the very low dollar wage levels prevailing in Russia, prices in Russia are supposed to be well below those in comparable market economies. To what extent have domestic prices converged to international levels after price liberalization? In a comparison of Russia and France (figure 3), it appears that overall consumer prices in Russia rose from about 6-7 percent of the French level in July 1992 (immediately following exchange rate unification) to 20-22 percent in July 1994, with prices of services lagging behind goods. It is likely results would be similar in comparisons with other market economies. Thus, the gap between domestic prices in Russia and foreign prices has remained wide, though it narrowed rapidly between 1992 and 1994.

As part of Russia's structural transformation, the relative price of services can be expected to rise significantly in the years ahead, since cost-recovery ratios are still low for many of them. An important policy implication of the remaining large gap between Russian and international price levels is that, even if tight financial policies and foreign competition were to contain price increases in the tradable goods sector, inflation could stay persistently higher in Russia than in Western Europe.

This article is based on the authors' paper, "Relative Price Convergence in Russia," IMF Working Paper, May 1995. The views expressed here are the authors' and do not necessarily represent those of the Fund.