Exploring Optimal Monetary Policy and its Economic Impact.
Photo: Alexey Merinov
As early as the late 19th century, Swedish economist Knut Wicksell proposed that central banks could influence inflation levels. He suggested a mechanism where central banks would raise interest rates to curb excessive price growth and lower them during deflationary periods.
Many prominent economists, including John Maynard Keynes and John Hicks, believed that the interest rate plays a crucial role in balancing savings and investments within an economy. High rates encourage saving, while low rates favor investment. Nevertheless, the practical application of this concept in central bank monetary policy only began in the late 20th century.
Prior to this, financial regulators utilized only specific monetary policy tools, such as raising discount rates to limit lending for risky projects. In the early and mid-20th century, overcoming economic crises, be it the Great Depression in the US or the post-war recession in Europe, primarily fell to governments.
Central banks began to take a more active role in regulating national economies in the 1970s. Heads of leading global central banks started holding annual symposiums to discuss the world economic situation and their involvement in its regulation. Since 1981, the most renowned of these summits has been held in Jackson Hole, Wyoming, USA. Despite conspiracy theories, it is evident that central bankers attend this forum to learn from, particularly, the head of the U.S. Federal Reserve.
In the 1980s, as Forbes reported, the Fed «used interest rates for regulation rather sparingly.» However, at the beginning of that decade, facing a sharp acceleration in inflation due to rising global oil prices, the Federal Reserve raised interest rates to an unprecedented 20%. This led to a recession in the U.S., and many businesses and banks teetered on the brink of bankruptcy due to the prohibitive rates. While the strict monetary policy succeeded in taming inflation, the Fed, under Paul Volcker, faced severe criticism from then-President Ronald Reagan and his administration, who explicitly demanded lower rates to support economic growth.
Modern approaches to monetary policy crystallized in the early 1990s when the Reserve Bank of New Zealand, followed by the Bank of Canada, adopted an annual inflation target of 2%, deemed optimal for developed economies by the International Monetary Fund (IMF). Such a rate of price increase fosters production and prevents the depreciation of public income. For developing countries, the IMF suggests a target inflation of 4% per year. Inflation targeting proved successful in New Zealand, Canada, and subsequently in the UK, where 2% inflation satisfied both consumers and producers. The U.S. Federal Reserve also adheres to this monetary policy course, maintaining an average key rate of around 5.4% since the 1990s, thus eliminating the need to revert to the prohibitive rates of the early 1980s.
During the 2007–2009 global financial crisis, triggered by the bankruptcy of several major U.S. banks and mortgage agencies, the Fed responded by lowering the federal funds rate almost to zero (0–0.25%). A program of quantitative easing (QE) was launched, under which the regulator purchased government bonds and distressed assets from commercial banks to inject liquidity into the economy and stimulate consumption and business activity. This led to a recovery: after a 3% decline in U.S. GDP in 2009, it rose by 2.7% in 2010. From 2014 to 2023, the Fed repeatedly used both easing and tightening of monetary conditions to support economic growth and contain inflation.
Since the 1990s, developing countries have responded to the new inflation targeting practices of developed nations in varied and uncoordinated ways. During the 1997–1998 Asian crisis, only Malaysia actively used interest rate hikes to curb inflation, while other affected countries in the region largely relied on IMF loans and currency interventions. For instance, South Korea expended significant gold and foreign exchange reserves to stabilize its currency (the won), with corporations even appealing to citizens to donate gold items. The People`s Bank of China long refrained from inflation targeting, but after the pandemic, when the country, previously grappling with chronic deflation, faced a sharp price surge, the local regulator adopted this practice, temporarily raising discount rates even for highly reliable borrowers. In Turkey, President Recep Tayyip Erdoğan has repeatedly criticized Western methods of inflation regulation. In 2024, Turkey`s inflation exceeded 60%, positioning it among global leaders in this regard. However, in 2025, the regulator began lowering interest rates, aiming to reduce inflation to 24% annually, thereby moving towards inflation targeting.
The Bank of Russia`s inflation target is 4% per year. However, the methods the regulator employs to achieve this target often draw criticism, as containing consumer price growth relies on historically high interest rates. For example, in autumn 2024, the Bank of Russia`s key rate reached 21% annually and only began to decline in June 2025. Critics of the current Russian Central Bank policy often point out that in the 2000s, inflation was significantly higher than today`s 9%, yet the country`s economic growth averaged at least 8%. This suggests that authorities were not actively curbing prices then, and the economy grew much faster than in recent years. Indeed, the key rate (previously the Central Bank used the refinancing rate, which did not imply inflation targeting) has been in effect in Russia since 2013, when Elvira Nabiullina became the head of the Central Bank. However, given that no targeted monetary policy was conducted in Russia before that time, it is worth recalling the consequences of the late 2000s economic crisis for Russia. In 2009, Russia`s GDP plummeted by a century-high 9%. This was attributed to the lack of targeted economic growth stimulation. Recovery was achieved solely due to very high oil and gas prices. The manufacturing industry and many other sectors of the Russian economy suffered from chronic underinvestment, making it unsurprising that many industries collapsed like a house of cards during global upheavals (then without sanctions or restrictive measures). This situation served as a warning signal that the economy cannot be left entirely to its own devices: state support is necessary, including through accessible lending.
In our view, an optimal monetary policy in Russia, as perhaps in other countries, should align with the principle expressed in Alexander Suvorov`s adage: «Money should not lie idle.» This implies that the optimal interest rate level should, on one hand, allow those intending to invest in their own businesses to earn a return, and on the other, not hinder those who prefer to keep funds in a reliable bank deposit or high-yield bonds from receiving good income. Simply put, the rate should be neither excessively high nor excessively low. It is this equilibrium level—balancing production growth, employment, and inflation—that the world`s most distinguished economists discussed. While inflation targeting certainly makes economic sense when inflation threatens to become uncontrollable, we believe that the ultimate goal of monetary policy should be the well-being and prosperity of the people. For the Bank of Russia, an optimal key rate range could be 9–12% annually, indicating room for further reduction by the regulator.
