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Inflation and Interest Rate Effects

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The opening of Russia's market has resulted in a highly volatile Russian currency (the ruble). Russia's inflation has commonly exceeded 20 percent per month. Russian interest rates commonly exceed 150 percent, but this is sometimes less than the annual inflation rate in Russia.

a. Explain why the high Russian inflation has put severe pressure on the value of the Russian ruble.

b. Does the effect of Russian inflation on the decline in the ruble's value support the PPP theory? How might the relationship be distorted by political conditions in Russia?

c. Does it appear that the prices of Russian goods will be equal to the prices of U.S. goods from the perspective of Russian consumers (after considering exchange rates)? Explain.

d. Will the effects of the high Russian inflation and the decline in the ruble offset each other for U.S. importers? That is, how will U.S. importers of Russian goods be affected by the conditions?

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This posting answers the student's question related to Inflation, Interest Rate Effects and Purchasing Power Parity (PPP).

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a. Explain why the high Russian inflation has put severe pressure on the value of the Russian ruble.

ANSWER: As Russian prices were increasing, the purchasing power of Russian consumers was declining. This would encourage them to purchase goods in the U.S. and elsewhere, which results in a large supply of rubles for sale. Given the high Russian inflation, foreign demand for rubles to purchase Russian goods would be low. Thus, the ruble's value should depreciate against the dollar, and against other ...

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