2014-21 Exchange rate in action

In today's report, Bloomberg writes about what is happening with the ruble exchange rate and exchange rate policy

• the ruble has been falling because  of sanctions imposed on Russia by developed countries (US, Canada, Australia, Japan and European Union) resulting from its aggression in Ukraine
• sanctions raise uncertainty, making Russian assets less attractive. So two things happen: 

1. capital flows out of the country
2. interest rates increase

• Russia has ample foreign exchange reserves: $515 billion in 2013 according to CIA Factbook (for comparison, US has $150 bln, Canada has 70 bln of reserves and China has $4 trillion)
• the current system of exchange rate management in Russia is as follows:

1. there is a basket of currencies in terms of which the ruble is controlled
2. the ruble is allowed to move within a band
3. if it crosses the band, the central bank sells or buys rubles on the foreign exchange market

• Russia is considering:

1. Introducing capital controls to stem the outflow of capital (one specialist says this will not happen until reserves start falling by $20 bln a month)
2. Flexible exchange rates

Here is an important sentence:
The central bank widened the ruble’s trading band in August as it prepares for the shift to a freely floating ruble, abandoning a 15-year policy of tapping reserves to control currency movements in favor of using interest rates to manage inflation. 

What it means:
- current monetary policy is to manage the exchange rate, by intervening on the foreign exchange market
- they want to switch to flexible exchange rates and use monetary  policy to manage inflation, by changing interest rates (like, for example, Bank of Canada does)

What it stresses:
-they can either control exchange rates or the inflation rate, but not both at the same time. Monetary policy can accomplish only one thing at a time.