The Domestic Financial System and Inflation

In addition to the external debt obligations, Russia inherited from the USSR a huge money overhang caused by the hidden budget deficits accumulated over many years. This overhang transformed hidden inflation (manifested in chronic shortages, long queues, and price growth in the non-official segments of the economy) into explicit price growth and yielded a tremendous outburst of inflation, once prices were liberalized in January 1992. The Russian reformers applied shock therapy based on the Polish experience of economic liberalization and macroeconomic stabilization. They intended to tighten monetary policy to suppress inflation by means of a nominal anchor and then to create conditions for stable economic growth. This programme worked effectively in the East European economies where macroeconomic stabilizations normally required two or three years. Unfortunately, the attempt to curb post-liberalization inflation in Russia was very short, and, because of the strong pro-inflatonary political pressure, the authorities began the monetization of huge budget deficits. The result of monetary expansion was real money squeezing that generated the problem of non-payments, an incurable disease of the Russian economy in the 1990s.