The ruble’s crash shrank the Russian economy drastically in dollar terms. As world oil prices climbed, the share of export earnings in GDP increased from 20–25 percent in 1994–97 to 50 percent in 2000. The share of fuel exports (oil and gas) rose from 9–10 percent in 1994–98 to almost 25 percent of GDP (although the fuel industry employs only about 1 percent of the workforce).

At the 1999–2000 exchange rate, the Russian GDP changes about 0.5 percent for every dollar-a-barrel change in the oil world market price. In the first half of last year the increase in Russia’s oil and gas export income alone accounted for 50 percent of the rise in the GDP. A dollar-per-barrel change in the oil price causes a 4 percent change in the economy’s ruble money supply, M2 (cash in circulation and deposits), or about a 1.5 percent change in the broader money supply, M2XX (ruble money plus foreign currency deposits plus estimated foreign cash in Russia). The current shift of lower oil prices and growing imports may help monetary policy in checking liquidity and can also help exchange rate policy keep the ruble stable—unless, of course, this shift continues.

In the first half of 2000, Russia produced a current account surplus of $23 billion, or 22 percent of GDP. Gold and foreign currency reserves rose from $12 billion at the end of 1998 to $27 billion in November 2000. Correspondingly, the monetary base also rose, which in turn has boosted the larger monetary aggregates. The year-on-year changes in M2 have been at least 50 percent since June 1999.

In contrast with the past, rapid money growth has not been reflected in consumer prices. However, increases in producer prices are clearly higher (by about 50 percent). The main reason for the discrepancy between money growth and inflation is the rapid decrease in the velocity of money.

What can the Russian authorities do to keep inflation at reasonable levels? If large current account surpluses persist, the increased liquidity in the economy must be sterilized or the monetary aggregates will grow. Sterilization of large capital flows is costly and cannot be a long-term strategy of a central bank. Moreover, the Central Bank of Russia currently lacks the tools to control money growth. To attain further monetization of the economy, a properly functioning financial sector is imperative—and reforms of the Russian banking sector have barely begun.

Excerpted from Vesa Korhonen, "Swings over Russian Economic Transition" (Russian Economy: The Month in Review December 2000) and Tuomas Komulainen and Iikka Korhonen, "The Dilemmas of Russian Monetary Policy" (Russian Economy: The Month in Review November 2000). The authors are economists at BOFIT.