An error correction model for Russian inflation

Abstract

his study examines how inflation has responded to changes in the rate of money supply growth in Russia.The study covers the period from January 1992 when price liberalization was introduced to December 1995.The error correction model uses an error correction term (i.e. 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 was felt within three months. Further, the error correction term is shown to have statistically significant coefficient with a correct sign, implying that deviations from long-term equilibrium contain useful information about future inflation. The model reinforces the observation that monetary policy inevitably plays the main 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, the financing of the central government budget through large deficits. Keywords: inflation, models, Russia