Presentation for Market Design course

My review of Budish, E., Cramton, P., Shim, J., (2015),
“The High-Frequency Trading Arms Race: Frequent Batch Auctions as a Market Design Response”

“Open economy and exchange rates” a unit for a Bachelor of Public Administration group.

“Стабилизационная политика” лекция для ГМУ

A presentation for Global Economic Governance course at GSOM Master Program. Here

Занятие 1. Макроэкономика для групп 1, 7, 8

Занятие 2. Макроэкономика для групп 1, 7, 8.

Занятие 3. Макроэкономика для групп 1, 7, 8.

Занятие 4. Макроэкономика для групп 1, 7, 8.

Занятие 5. Макроэкономика для групп 1, 7, 8.

Занятие 6. Макроэкономика для групп 1, 7, 8.

Занятие 7. Макроэкономика для групп 1, 7, 8.

Developing countries with fully opened capital account are overexposed to boom and bust cycles in international credit flows. During boom, they borrow too much enjoying the capital inflow disregarding the risk; during busts, the flow turns around (sudden stop) triggering the financial crises. The flood of capital into Latin America in 80s, or in East Asia in 90s were no exceptions, those episodes just repeated that destabilizing pattern. Recent empirical literature has established a strong relationship between capital market liberalization and financial instability.

Unrestricted capital mobility pose huge welfare costs for developing economies, the acknowledgement of this fact led some countries to start imposing prudential control on international capital flows. The global financial crisis invigorated experiments with capital control. Taiwan, Korea, Indonesia, Thailand and Brazil introduced curbs on capital inflows in 2009 and 2010.

The proposed study has the objective of developing a dynamic stochastic general equilibrium (DSGE) model to quantify the parameters of welfare maximizing ex-ante macroeconomics policy. The research focus is on microfoundation of “overborrowing” in developing countries. (this is actually my research proposal for PhD in Economics)

Welfare-based analysis of the gains and costs of capital flow management for individual countries and the rest of the world is a very recent area in macroeconomics. Until recently, theoretical literature could not explain a wide variety of capital account policies that we observe in both developing and developed countries. Meanwhile, welfare benefits for trade international cooperation have been widely studied, however welfare benefits for international cooperation of capital account policies (Costinot et al, 2011, an exception) is completely a new ground. Yet, those topics are highly connected, since real exchange rate can be distorted by managing capital account. Issue of opennes of capital account needs futher research.[1]

Modern capital controls were developed by the belligerents in World War I to preserve a tax base to finance wartime spending. Controls began to disappear after the war, only to return during the Great Depression. At that time, their purpose was to permit countries greater ability to reflate their economies without the danger of capital flight. In fact, the International Monetary Fund (IMF) Articles of Agreement (Article VI, section 3) signed at the Bretton-Woods conference in 1944 explicitly permitted capital controls. One of the architects of those articles, John Maynard Keynes, was a strong advocate of capital controls and the IMF often was seen as such during its early years. During the Bretton-Woods era of fixed-exchange rates, many countries constrained asset transactions to cope with balance-of-payments difficulties. However, recognition of the costs and distortions created by these restrictions led to gradual removal of all limitations on buying and selling of both stocks and bonds internationally during the 70s and 80s. The United States, for example, removed its most prominent capital controls in 1974. During the 1990s, mostly under the pressure of developed economies, developing countries began to liberalize trade in assets as well. (Neely 1999). Before 1999 contrary to many topics in macroeconomics, capital controls have received cursory treatment in textbooks and scant attention from researchers. In the early 2000s, the established consensus that capital controls – like tariffs on goods – obviously detrimental to economic efficiency begun to break down. Large capital flows to developing countries in 80s and 90s posed a new problem to policymakers. Then a series of exchange rate/financial crises in both developed and developing countries in 90^th. Today the global financial crisis has been followed by experiments with capital control. Taiwan, Korea, Indonesia, and Thailand introduced curbs on capital inflows in 2009 and 2010. Brazil in October 2009 introduced a pro-cyclical tax in all capital inflows except FDI; these measures are consistent with the last academic advancement in this area of macroeconomics. Today IMF again endorses capital controls as useful policy responses to certain circumstances (Blanchard 2012).

Recent crisis drew attention to credit booms. Schularick and Taylor (2009) after analyzing the dataset for the years 1870-2008 covering 12 developed countries, where they decoupled money and credit aggregates, showed that leverage in financial sector has strongly increased since the second half of the 20^th century. At the same time, there has been a fall in safe assets on banks’ balance sheets. From 1870 until 1939, money and credit were volatile but maintained approximately steady relationship to each other and to the size of the economy (the Great Depression is an exception). After WW II, the huge growth in the use of credit and increasingly complex forms of leverage, along with a steady decline in bank-held safe assets such as government securities, led to an unprecedented level of risk throughout the credit system up to 2008. They assumed that the belief that central bank would prevent the collapse of a nation’s currency (moral hazard) led to this unprecedented risk tolerance by private sector. The main observation, however, is that behavior of credit aggregates is the single best predictor for the likelihood of future financial instability. The long-run record shows that recurrent episodes of financial instability have more often than not been the result of credit booms gone wrong. The policy implications are straightforward; credit cycles need supervision and moderation.

Situation in credit cycles for developing countries is much more perilous. Developing countries exhibit financial amplifications.[2]  When a country experience shocks that lead to a decline in aggregate demand, their exchange rates depreciate and asset prices fall. This results in a declining value of collateral (balance sheet effects). In the presence of financial market imperfections, such balance sheet effects constrain the access of economic agents to external finance, which in turn forces them to cut back on their spending and contract aggregate demand further. In other words, a financial amplification is a mechanism that amplifies economics shocks.[3] Noteworthy is that exactly this amplification is happening right now in Russia, where I am writing this proposal. Russian economy is having too much debt with short maturity nominated in foreign currency. The fall in oil prices and sanctions led to a devaluation of local currency that, in turn, devalued assets, including collateral and this further contract the aggregate demand. Russian monetary authorities made a mistake that led to a “twin” crisis that was first noticed back in 1999. The idea originates from the paper by Kaminsky and Reinhart (1999). In this empirical paper researcher found that problems in the banking sector typically precede a currency crisis and that a currency crisis deepens the banking crisis, activating a vicious spiral. Importantly, they also found that financial liberalization often precedes banking crises. Similar results were repeated in different papers using other methods (e.g. Glick and Hutchison, 1999). The punch line that that openness of emerging markets to international capital flows, combined with a liberalized financial structure, makes them particularly vulnerable to, first, currency crisis and, second, banking crisis.

Carlos Diaz-Alejandro (1985) gave an insightful explanation of how reforms for freeing domestic capital market and financial innovation leads to financial crises. The boom-bust credits patter he described primarily in context of Latin America is universal (Reinhart 2014). Overborrowing of private sector is the outcome of moral hazard, which arises when investors believe they will be bailed out of bad investment by the taxpayer. This bailing out may be carried out by the treasury, the central bank, or by international agencies. In this sense, the taxpayers subsidized the investments. Current empirical literature validates the assertions of Diaz-Alejandro. Recent empirical work, Magud, Reinhart, and Rogoff (2011) merged 30 empirical studies and concluded, among other things, that limiting private external borrowing in the “good times” plays an important prudential role, because more often than not countries are “debt intolerant”, in other words banks cannot withhold a sudden stop. In general terms there is a consensus that international financial integration and openness to capital flow provide little if anything by way of boosting long-run growth (Jeanne 2012). In a way, two economists Kenneth Rogoff and Carmen Reinhart in 2008 drew a line in empirical evidence. Most empirical works had been focused on two or three decades of data, but Rogoff and Reinhart analyzed eight centuries of data and found that capital mobility has a direct relationship with incidences of financial crises (Reinhart and Rogoff 2008). Interesting that in early 2000s, as demonstrated in a voluminous literature review by Joshua Aizenman (2004), financial opening was seen as a complicated trade-off. Some researcher was able to associate a financial opening with a higher rate of growth, meanwhile opening and liberalization is risky, so it should be done but with proper prudence.

The fact is established – the world failed to live up to the purity of classical models. Unrestricted capital mobility pose welfare costs for economies, especially for developing, where welfare costs of macroeconomic volatility are particularly large (Loayza et al. 2007) and where markets often fail or/and instistutionas are weak.[4] For a developing country, instruments such as dollar debt are comparatively cheaper, but they impose risk on borrowers in case the exchange rate depreciates. These debts also do not involve risk sharing, like local currency debt or, even more so, equity and FDI. Borrowers do not internalize the exchange rate risk that these actions pose on balance sheet. As a result, they unintentionally contribute to financial amplification. In a way, financial fragility is an uninternalized side-product of external financing, just as air pollution is an uninternalized side-product of driving. It is optimal for drivers to enjoy the benefits of their mobility while disregarding the pollution that they impose on the rest of society, since each driver knows that her individual contribution to air pollution is minuscule. In aggregate, however, there will be excessive pollution if all drivers act this way. In other words, clean air is a public good and will be subject to a “tragedy of the commons” in the free market equilibrium (Korinek, 2012). The described outlook shapes a natural role for ex-ante policy intervention, or prudential capital control.  The best example of this policy today is a Brazilian pro-cyclical tax mentioned earlier. In a way, it is a Tobin (1978) tax that “throw some sand in the wheels of our excessively efficient international money markets” because real factors such as capital and labor cannot keep up leading to painful episodes of adjustment in the real economy. Again something that I observe today in the ongoing situation in Russian economy. Rapid devaluation of ruble caused a cost-push inflation that, in turn, created an inflation expectation, so that prices on all products, with different time lags, are getting high. That, in turn, would cause nominal wages to go up. The period of constantly changing relative prices along will stumble growth.[5]

Excessively volatile credit cycles with over-borrowing problem and financial fragility (exchange rate risk and balance sheet effect) cost a lot in term of welfare for developing countries. First reason for that is deviation from a smooth path consumption. Second reason is a negative impact on output growth and thus on future consumption. Ramey and Ramey’s seminal paper first empirically documented the effect of volatility on growth back in 1995. Most literature on the empiric of financial liberalization relies on cross-country methodology; posing a serious pitfall on evaluating the net-welfare effects. There is no conclusive data to understand if Korea would have been better off by refraining from financial opening in the early 1990s, or if Chile would have benefited by retaining financial repression in the 1980s and 1990s. Some economists (e.g. Haggard 2000) argue that Korean crisis of 1997 could have prevented much deeper and longer calamity, like the one in Japan. The beginning of both crises had common nature – domestic banks accumulated nonperforming loans over time. Meanwhile, Chile’s GDP tripled since the beginning of 2000s and country has a sound banking system, and one could say that it was the result of the painful earlier reforms that were triggered by the crises of the early 1980s.

That is why a formal welfare-based analysis is required. It is quite possible that the private sector fully recognize the risk of a potential aggregate shock and include it in their decision. The fact that agents borrow at a very large extend could be because gains from increased investment today fully compensate for the costs of financial troubles in the future. Therefore, the task is to show overborrowing in equilibrium to warrant ex-ante intervention. It has been archived (financial amplification is exactly this fact relabeled) by capturing exchange rate, price or interest rate externalities (Korinek, 2012). The new area is quantification of optimal tax and welfare costs, the best method for that would be a DSGE model. There are examples of this approach. Bianchi (2011) quantified welfare gains and optimal tax rate for Argentinian data. As in Lorenzoni (2008), he analyzed constrained efficiency by considering a social planner that faces the same financial constraints as the private economy, but internalizes the price effects of its borrowing decisions and then calibrated the model to get the numbers. In order to specify meaningful DSGE model I would need to study overborrowing problem on micro-level first, however as a hypothetical research direction the work by Bianchi (2011) can be extended by including explicit role for financial intermediation, as in for example Gertler and Karadi (2010).

Bibliography

Aizenman, Joshua. 2004. “Financial Opening: Evidence and Policy Options.” Challenges to Globalization: Analyzing the Economics (University of Chicago Press) 473-94. http://www.nber.org/chapters/c9547.pdf.

Bianchi, Javier. 2011. “Overborrowing and Systemic Externalities in the Business Cycle.” American Economic Review 101 (7): 3400–26. http://econ.as.nyu.edu/docs/IO/18565/Bianchi_20110113.pdf.

Blanchard, Olivier, and Jonathan Ostry. 2012. “The Multilateral Approach to Capital Controls.” December 11. http://www.voxeu.org/article/multilateral-approach-capital-controls.

Costinot, Arnaud, Guido Lorenzoni, and Iván Wening. 2011. “A Theory of Capital Controls as Dynamic Terms of Trade Manipulation.” Unpublished. http://economics.yale.edu/sites/default/files/files/Workshops-Seminars/International-Trade/costinot-111116.pdf.

Diaz-Alejandro, Carlos. 1985. “Goodbye Financial Repression, Hello Financial Repression.” Journal of Development Economics 19 (1-2): 1–24.

Gertler, Mark, and Peter Karadi. 2010. “A model of unconventional monetary policy.” Journal of Monetary Economics. http://www.econ.nyu.edu/user/gertlerm/GertlerKaradijournal.pdf.

Glick, Reuven, and Michael Hutchison. 1999. “Banking and Currency Crises: How Common Are Twins?” (Federal Reserve Bank of San Francisco). http://www.frbsf.org/economic-research/files/glick_hutchison.pdf.

Haggard, Stephan. 2000. The Political Economy of the Asian Financial Crisis. Washington,: D.C.: Institute for International Economics.

Jeanne, Olivier. 2012. “Capital Flow Management.” American Economic Review 203-206. http://www.econ2.jhu.edu/People/Jeanne/OJeanne_AERPP_2012.pdf.

Jeanne, Olivier, Arvind Subramanian, and John Williamson. 2012. Who Needs to Open the Capital Account. Washington: DC: Peterson Institute for International Economics. http://www.piie.com/publications/chapters_preview/5119/05iie5119.pdf.

Korinek, Anton. 2011. “The New Economics of Prudential Capital Controls: A Research Agenda.” IMF Economic Review 59 (3). https://www.imf.org/external/pubs/ft/wp/2011/wp11298.pdf.

Krugman, Paul. 1999. “Balance sheets, the transfer problem, and financial crises.” International Tax and Public Finance (6): 459-472. http://www.ide.go.jp/English/Publish/Download/Report/2006/pdf/2006_04_18_02.pdf.

Loayza, Norman, Romain Ranciere, Luis Serven, and Jaume Ventura. 2007. “Macroeconomic Volatility and Welfare in Developing Countries: an Introduction.” The World Bank Economic Review 21 (3): 343–357. http://www.romainranciere.com/research/WBER.pdf.

Magud, Nicolas, Carmen Reinhart, and Kenneth Rogoff. 2011. “Capital Controls: Myth and Reality – a Portfolio Balance Approach.” National Bureau Of Economic Research Working Paper 16805. http://www.nber.org/papers/w16805.pdf.

Mendoza, Enrique. 2002. “Credit, Prices, and Crashes: Business Cycles with a Sudden Stop.” Preventing Currency Crises in Emerging Markets (University of Chicago Press). http://www.nber.org/papers/w8338.pdf.

Neely, Christopher. 1999. “An Introduction to Capital Controls.” Federal Reserve Bank of St. Louis Review 13–30. http://research.stlouisfed.org/publications/review/99/11/9911cn.pdf.

Ramey, Garey, and Valerie Ramey. 1995. “Cross-Country Evidence on the Link Between Lovatility and Growth.” American Economic Association 85 (5): 1138-1151. http://econweb.ucsd.edu/~vramey/research/Ramey_Ramey_Volatility.pdf.

Reinhart, Carmen. 2010. “Eight Hundred Years of Financial Folly.” May 05. http://www.voxeu.org/article/eight-hundred-years-financial-folly#f7.

—. 2014. “Why Reading Diaz -Alejandro is Essential for Understanding Financial Crises.” São Paulo: LACEA. http://www.carmenreinhart.com/user_uploads/data/47_data.pdf.

Reinhart, Carmen, and Kenneth Rogoff. 2008. “This time is different: a panoramic view of eight centuries of financial crises.” National Bureau of Economic Research. http://www.nber.org/papers/w13882.

Schularick, Moritz, and Alan Taylor. 2009. “Credit Booms Gone Bust: Monetary Policy, Leverage Cycles and Financial Crises, 1870-2008.” The National Bureau of Economic Research (Working paper 15512). http://www.nber.org/papers/w15512.

Tobin, James. 1978. “A Proposal for International Monetary Reform.” Eastern Economic Journal 153-159. http://cowles.econ.yale.edu/P/cd/d05a/d0506.pdf.

[1] See Korinek (2011), Jeanne (2012) for explicitly stating numerous research agendas in this area

[2] A financial crisis in developing country can be modeled as an episode of financial amplification (e.g. Krugman, 1999; Mendoza 2002)

[3] This “amplification” mechanism is also known in literature as debt deflation, Fisherian deflation, or financial accelerator. A simple model of financial amplification that analytically demonstrates this mechanism can be found in Korinek (2011)

[4] As in Leo Tolstoy’s famous quote, perfect markets are all the same; every imperfect market is imperfect in its own way.

[5] There is a huge shortage in both ruble (short-term panic of selling ruble assets and increased official interest rate) and dollar (a drop in oil prices decreased dollar incomes, while sanction forced agents to amass dollars to payoff external debts, because latters could not be rolled over any more) liquidity in Russia, yet central bank can’t satisfy demand even for ruble liquidity, because that will justify inflation expectation and surge long-term interest rate making investment in ruble even more expensive. It is a shame that Russian central bank abandoned dollar interventions too soon (since 2009 a policy of inflation targeting was announced, because in 2008 central bank prevented ruble from devaluation after the drop in oil prices, exactly to save dollarized bank sector, that prevention caused a monstrous capital outflow and contracted Russian economy by 8%. However, Australian and New Zealand experience of 1997 is already a textbook example why Russian central bank should not have done it). This was exactly the time when interventions would save economy from panic.

Transition to market economy in Russia, unlike its Eastern European Comecon partners, proved to be lengthy and arduous. Hyperinflation initiated in 1992 lasted for at least 4 year, while recession even longer. Most evident reasons for recession were falling of both investment and military expenses, those reasons accounted for 50% of industrial decline from 1991 to 1995. Nonetheless, recession took place in the most unexpected sectors, like, a production of food. Steady economic growth resumed only in 2000 after unheralded shocking therapy of 1998. The main designer of the reforms Yegor Gaidar was hoping for relatively fast economic transformation, but it took long 7 years and when everybody started to believe that market economy is impossible in Russia the growth took place. Reforms took so long due two reasons: absence of national payment system and mental inertia of soviet enterprises.

A priori, a central idea of reforms of overcoming the shortage in the consumable commodities by liberalizing prices and theirs consecutive stabilizing looked impeccable. Late USSR had a huge deficit of products, while people had enormous saving, buying a car required being on the waiting list for many years. Initial jump in prices was supposed to not only take away excessive amount of money from population, but also always plug the holes from which new money poured into economy.

During the first period of price liberation, January-May 1992, the problem of restraining of money in circulation was central for both the government and Central Bank. Tight control of the money supply was considered as the most important, and, essentially, the only way, to prevent sliding of the economy into hyperinflation. In retrospect, that was the most proper policy, which was implemented quite successfully due to both apt planning and fortunate spontaneously factors. Initial growth rate of the quantity of money in circulation around 9 – 13% per month. It still gives about 200% per annum, however in those macroeconomic conditions it was a victory. Huge initial jump in prices allowed to balance the budget. The government budget could become the main source of pumping money into economy, due to social obligation, yet they were incremented only 3 times. By January 1992 average pension were $3 per month, by the end of the year Ruble strengthen, but average pension made up to $7 per month. Meanwhile, average salary for the same period jumped from $7 to 39$ per month. Meaning the government did not increase pension, a budget outlays, to keep pension to salary ration constant. Credit emission (money base) of Central bank was only 8%.

Nonetheless, tight monetary policy was not that important. Inflation was not monetary in nature, it was cost driven. Taxation novelties changed the relation of wholesale to retail prices (in USSR companies were adding costs along the production line, no taxes or profits existed) and most enterprises tried to keep the same pre-reform level of real wages shifting costs to final product. Expectations of liberalization of energy prices also precipitated the inflation, while an actual increase took place on May 18, 1992. The contraction of the monetary supply did not effect the real economy, deepening recession were almost entirely determined by supply side factors. Falling demand and difficulties with sales in several industries forced companies to manufacture for stock, which fully met companies’ interests during hyperinflation. As the result, curbing of the money supply has not led to the stabilization of prices on the equilibrium level, but to rapid accumulation of trade credits which have led to interlocking webs of arrears among enterprises. This phenomenon called soft budget constraints, or virtually limitless source of credit for enterprises.

The first reason for arrears was a settlement principle of Soviet economy that companies kept following. Almost most settlements were based on payment requests. Simultaneously with shipment of products (rendering of service) provider send a payment request in bank. In many cases (electricity, transportation) provided did not even needed the acceptance from account owner. Chances of not having a required money on account were almost nil. In case of liquidity problem State Bank almost automatically lend money to enterprise. However, paying incapacity would put the enterprise on so-called “card-index number 2” and the director’s professional suitability would be questioned. This system without any change migrated to the market economy, which formally became so on January 1, 1992. With this system, the amount of money in the economy does not limit the demand, and as the result, the price inflation. In Soviet economy, there were no need for it, since all prices were dictated. However, in new environment price growth of purchased products did not worry enterprises, since they automatically shifted the price growth to its own good. The same thing happened with the rates of loans. As the result, higher interest rate led to even higher inflation. Non-payment from the costumers was compensated by non-payment to supplier, which essentially, was a credit from one enterprise to another. Signals of overpricing and lack of demand could come only from retailer sector, to which this “commercial loans” did not apply, at some point retailers would stop buying too expansive products. Meanwhile, produces would also stop supplying chromic non-payers. Demand restrictions that could stop eventual overpricing did not works since inflationary expectations made reasonable to accumulate unsold inventory, which could have been used as the collateral. When demand restrictions finally reached the producers, the only reaction available was to reduce output, not prices.

The second reason for arrears was transition of national payment system from interbranch turnover to correspondent accounts. Since 1933 all banks (all bank were, in fact, departments of the State bank) used interbranch turnover accounting for interbank settlements. Money always reached the recipients regardless of the interbank balance at the moment of transaction, moreover, the balance of a bank with respect to other bank played no role. Essentially, it means automatic interest-free and unlimited interbank credit, resources of individual banks did not require any demarcation. In 1988, five special-purpose banks were added over the existing banking system. Those banks used the same interbranch turnover accounting to get loans from the State bank, which means that in addition to existing emission center five more were added. In planned economy that system was stable, but since the beginning of reforms in 1990, system became uncontrollable and economy started to sink in the sea of money. To gain control over emission the newly founded Central Bank of Russia had correspondent accounts, the accounts of banks in the central bank. The main difference of the new system was requirement for bank to have positive balance that, in turn, gave Central Bank control over the emissions. The new system had a huge drawback: an extremely low speed for settlement operations. Within one region, say Moscow, situation was bearable, but it could take a week for transactions between different regions. New two-tier bank system failed test in the real time, rather unfortunate coincidence, as is always the case, with a critical period of reforms in other areas.

The last reason for interlocking webs of arrears was deep structural disbalance of prices, the heritage of Soviet economy. Deliberate disbalance was a social policy of USSR, for example, price for fuel and raw materials, energy, transportation and for many other categories were kelp relatively low. Low prices worked as hidden subsidizing for many industries. For example, one-bedroom apartment in Moscow was cheaper than a car. Low prices also facilitated access to fuel and energy in regions, which did not have fossils of their own. Low prices and direct subsidizing were leveling out living standards across different regions of USSR. Obviously, with such prices many industries did not break even. Basic mass of investment, including investment in circulating capital, was carried by centralized budget, which, in turn, collected all undistributed balance residual (“profit” in market economy). Even depreciation charges – income, in essence, – were transferred to the budget of the ministry, which is in charge of the given industry. Many industrial enterprises, especially in extraction, were planned money-losers and all losses were covered by centralized budget. For example, coal was gratuitous in comparison with today’s prices, but raising prices to at least industry average break-even production level would immediately affect food prices, which was impossible, especially after Novocherkassk uprising in 1962. Another example is agricultural (which were unprofitable, for the most part, because of low selling prices), where seasonal crediting had form of recursive “debt forgiveness”. Ironically, but after market equilibrating prices for farms the need for subsidizing villages did not seize, even became more grave. Hyperinflation during planting-harvesting cycle burnt all profits of villagers and they were simply giving harvest free, rather than for reduced prices as before.

In 6 month since the beginning of the reforms money started to matter, but they became less controllable. First reason was that demand for and circulation of real money (as distinct from above-mentioned webs of arrears) more or less stabilized. Reduction of enterprises’ real money balance levels out and for quite some time keeps at rather low level, around 12-15% of before price liberalization quantity. Further increase in money circulation is technically impossible, only if by paying salaries every day or even several times a day, what actually happened during the peak of hyperinflation. By the summer 1992, population normalized the cash leftovers, bringing it close to the purchasing level as for January 1. Normalizing of real money leftovers indicated that process of filling “cash-money niche” that opened during hyperinflation finalized ended. That had a dire consequence, if approximately from April until June 2012 most of cash emission fall into this niche, being amassed by population, then later emission had direct effect on the commodity prices. Second reason was that money supply in period April-June was increased by factors not controlled by Central Bank. Accretion of assets of trade balance among ruble trade zone (Russian Central Bank had a corresponding account with central bank of each trade partner), on one hand, increased demand for Russian products, on another hand, that ruble income not spent for import from those trade partners splashed out to commodity market, increasing inflation. In mid-1993 corresponding accounts for former soviet republics were closed (strictly speaking Ukraine and Baltic countries switched to new currency long before that).

Growth of the monetary base beginning from May approached 50% per month (that could be determined as hyperinflation). While growth of M2 (money supply) first 5 months ranged from 9% to 14% per month and accelerated to 28% per month. Largely lagging of money supply from potentially possible was due to the lack of banknote that did not match the new price level. By the second half of 1992 all money supply limits were completely removed. Ignoring of budget social obligations were not possible because of pressing social problems, so government and Central Bank started to amplify inflation. Since July budget deficit reached 25% of GDP and was financed by Central Bank, while credits to commercial bank started to snowball. Most money supply goes into economy as subsidies to faltering industries, eventually, that propelled the crediting activity of commercial banks and rained down to currency market. From then on the main problem became the budget balancing.