Diagnostic challenges. As in many other countries, there is a problem in diagnosing the causes and corrective measures for inflation. If the price increases are entirely attributable to global pressures on food and oil, and if some easing of those global price pressures is expected, there is no call for the authorities to pursue more restrictive monetary and fiscal policies; inflation will slow without the need to dampen robust domestic growth.

However, there is evidence that the Russian economy is beginning to overheat. Unemployment has been falling since 2003, and real wage growth has been accelerating away from labour productivity growth since 2004. Reports of strikes and other worker protests indicate increasing worker activism in pursuit of higher pay or other benefits. This is not surprising, as shortages of skilled labour are widely reported, and the overall pool of manpower is on the verge of shrinking.

Accelerating wage growth. A wage-price spiral bringing accelerating inflation is a risk in many countries, but this risk appears to be comparatively high in Russia. Rising food prices have been especially challenging for middle-income Russian households. A recent survey found that 61% of the population were in households whose food spending was half or more of their total spending. As prosperity increases, the share of household income spent on food will decrease in the long term. However, for the time being, rising food prices probably exert more upward pressure on wage demands than they do in developed economies.

Russians have become accustomed to very rapid real income growth, of the order of 15% a year. That has been more than twice the growth rate of labour productivity. In one respect, this disparity has been sustainable: as oil prices have risen, rapidly improving terms of trade have allowed real aggregate demand to outpace the growth of production. However, this does not negate or ameliorate the problem of rapidly rising unit labour costs.

Policy implications. If the Central Bank of Russia (TsBR) and the Ministry of Finance are allowed to oversee economic policy, Russian inflation can probably be brought back under control, but it will not be easy. Prudent fiscal policies are at risk from political pressures to accelerate spending on health, education, infrastructure and defence.

The TsBR has been moving towards inflation targeting, trying to leave the exchange rate to move more freely. However, its efforts are not being helped by the increasing net inflow of private capital. The Russian authorities have arrangements in place for sterilising a large part of the inflow of petro-dollars, but not for sterilising large inflows on capital accounts.