Monetary Regime Choice and Optimal Credit Rationing at the Official Rate: The Case of Russia

Stabilizing monetary policy in a small open economy is constrained by the open economy trilemma. In a crisis this constraint may not allow the Central Bank to cut interest rates because this may cause significant capital flight and the ensuing problems. In this paper we investigate whether the Central Bank’s credit rationing at the official rate (CROR) may soften the open economy trilemma constraint and improve the results of monetary policy for different monetary regimes. We construct a DSGE model appropriate for analysing the forward-looking behaviour of households facing a non-zero probability of credit rationing at the official rate. A simulation of estimated on a Russian data model and welfare optimization exercises allow us to contribute to the question of optimal monetary regime choice and to analyse the role of credit rationing for different monetary regimes. We have found significant credit rationing in the quarterly Russian data of 2001–2014. The share of liquidity constrained (non-Ricardian) households and the probability of CROR are estimated as 22% and 66% respectively. Welfare maximization exercises reveal a trade off between low-inflation and high-welfare solutions and favour of a floating exchange rate regime. Researching CROR gives mixed results. On the one hand we found the optimal value of the probability of CROR in both exchange rate-based and Taylor rule-based models. On the other hand the resulting improvement in welfare is very small.