A vector error correction model for prices, money, output, and interest rate in Russia

Abstract

This study examines how inflation and money supply growth have interacted in Russia.It covers the period from January 1992, when price liberalization was introduced, to December 1997.An error correction model includes an error correction term (ie deviation from long-run equilibrium) extracted from the estimated long-run money demand function. When the error correction term was included, it was found that much of the effect of monetary expansion on inflation was felt within three months.Further, the error correction term is shown to have a statistically significant coefficient with the correct sign in the money demand equation, implying that deviations from long-run equilibrium contain useful information on future monetary growth. The model reinforces the observation that monetary policy inevitably plays the key role in reducing inflation.Thus, if a reduction in inflation is desired, the central bank may find it impossible to reconcile this goal with other obligations, for example, with financing of the central government budget via large deficits. Keywords: inflation, models, Russia