Short-Term Inflation Forecasting in the Russian Economy

Abstract

This study using VECM methodology constructs a model of the Russian economy from 2010 through 2022 across four variables: consumer price index, ruble exchange rate against the US dollar, consumer demand, and the RUONIA interest rate. A short-term inflation forecast through the end of 2022, which predicts that annual inflation will drop to 10.1 % by December 2022, is arrived at based on this model. The model is then applied to determine the contribution to March inflation from the price shock that was not attributable to the dynamics of the fundamental variables. The point estimate of the shock came to 6.6% of the 7.4% seasonally adjusted March inflation, and this implies that about 89% of the inflation surge was due to one-off factors (logistics, switching to other suppliers, etc.). The accuracy of the VECM model forecast in the current economic situation (high inflation volatility) turns out to be higher than the accuracy of univariate benchmark models over a horizon of one to three months. Forecasts derived from the proposed VECM model applied to vintage data for the period from December 2021 to June 2022 turned out to be close to the consensus forecasts of analysts and the Bank of Russia, which had been based on a comparable information set. The forecasts constructed with the model project a significant slowdown in inflation based on data starting from April, an outcome which explains the rapid key rate cut by the Bank of Russia from 20% in early April to 8% by the end of July. Even when inflationary trends are rapidly changing, the proposed factor model facilitates prompt and relatively accurate short-term inflation forecasts, which can be used to inform monetary policy choices