Yuriy Gorodnichenko: “10% rate inflation is definitely not a favourable option for Ukraine”

About the government’s philosophy of helping Americans

Yulia Mincheva: The last week Biden signed The US Rescue Plan for $ 1.9 trillion. This is the third such a support package, which is adopted during the “covid” period in the United States. And the first one from the new President. The package includes many components, but the main focus is on helping the disadvantaged. In addition, significant costs are planned on infrastructure, the opening of schools, and much attention is paid to vaccination and mass testing. Compensations are also provided for the industries most affected by the lockdown. Millions of citizens should receive direct payments in the amount of $ 1,400 by the end of this month. What do you think about this package? What is the first key there, what will the money be spent on? 

Yuriy Gorodnichenko: Yuliya, I am sympathetic to this package. Its structure is similar to what has been done twice before. But now the priorities are a little bit different. For example, now there is less direct help for firms. Instead, more money goes to local budgets. This is good because most local budgets are suffering heavily from the crisis.

YM: Tax revenues from business are low because of the quarantine.

YG: Yes. And at the same time, local authorities are responsible for vaccination, opening schools, universities, etc. They have additional costs that need to be covered. The philosophy of this package includes two points. First, there is a state of emergency in the country, many people have died. So, people need some help directly. It’s like a natural disaster: a flood or a blizzard. Second, when there is an economic crisis in the country, it is necessary to stimulate the economy. Money is given to people not only to provide the minimum conditions for survival during the corona-crisis, but also to stimulate the demand. And thus “to pull” the economy to pre-crisis levels.

YM: Will this money really increase the consumer demand? According to the experience of the first aid packages, due to the stricter quarantine, the economic activity of many industries, especially services, has been suspended. Therefore, part of this money was spent not on consumption, but on savings, and in particular on stock markets. Will  there be the same situation with money this time? Or  is there any hope for a revival of economic activity this year comparing with the last year, because of the active vaccination? And how will it affect the inflation?

YG: The researches (including mine) show that the funds of the first rounds of government assistance were distributed as follows: about a third part was for living, a third part was for savings and the last third part was for payments of previous debts. Due to the fact that only a third part of the money was for living, the transfer of money directly to people was not very effective, if to talk about the priming of economy. But we should understand, that was happening in an extremely crisis situation, when everything was closed and nothing worked, and no one knew what would happen tomorrow.That is why people did not want to spend this money, saving for a rainy day. Today, about a third of the population in the United States has been vaccinated. So, the chances, that people would spend this money, have increased. Second, the aid plan was changed somehow. Transfers are aimed at people who are more likely to spend this money on consumption, than on some crazy investment. The combination of these two factors – opening the economy and better aid targeting – gives hope that this round of stimulation will be more effective. 

Andriy Fedotov: What is the current discussion about that presidential initiative in the United States? Are there those who disagree with this idea, and what are their arguments?

YG: Yes, there are people who do not agree with this program. They say that this amount of motivation is too great. But it is important to understand that the challenges are much greater. For example, the number of people employed in the US economy reduced by 10 million compared to pre-crisis times. Given the data, I don’t think there can be systematically high inflation in the United States any time soon. This is very unlikely. 

AF: How do you assess the impact of this “package” on economy in general, on government debt, inflation?

YG: As for the debt, the situation is clear. The US government borrows a lot of money. Will it be able to borrow two trillion dollars more? I think there are no questions here – it will be able to. Financial markets are extremely “hungry”, they are ready to buy the US government’s debt in almost any amount. The problem, of course, is that someday these debts will have to be repaid. But the economic theory is very clear: debts must be taken during the crisis, and they should be repaid during the economic boom. 

The United States has a very good credit history. There had been many examples, when after debt accumulation periods, the US government put efforts to reduce the debt burden. For example, during Bill Clinton’s presidency, US’ debt reduced very quickly. In the late 1990s, there were even discussions about “what to do when we pay all the debts off?” After World War II, there were huge debts, and almost all of them were paid by the States. Even the governments of presidents who said they would never raise taxes to control debt — Ronald Reagan and George Bush Senior — raised taxes to solve the problem with debt and budget deficits. That is why I think that debt reduction will be one of the most important tasks if not for Biden, then for his successor. But this problem needs to be solved when the economy stands on feet and flourishes, but not today when everything is unravelling.

About the economy of Ukraine

AF: And do you think, should Ukraine borrow more and spend more?

YM: In general, we buy debt much more expensively…

YG: Let’s think about what it means to borrow and return. For example, the USA government never declared a default, they always returned the money. There have been several defaults in Ukraine. So why can’t we pay our debts? Or are there any institutional restrictions on how much we can borrow? For example, when Ukraine wanted to borrow during a pandemic, it was very difficult to borrow money without the help of the IMF. Now our cooperation with the IMF has been suspended. 

We have access to foreign markets, but this is a very uncertain situation. Because one day it may happen that it will be difficult to borrow for Ukraine. But more important are the terms it will be on. The USA government takes money almost for free – at 1% or 2%. The Government of Ukraine takes at about 10%. This is a very high price, and this is the price that Ukraine pays for its past and current actions. When nobody knows for sure, how these debts will be paid, who will be in the next government, who will head the NBU and what terms the NBU will work on in general.

Borrowing money, it is also important to understand what is happening with inflation. For example, the Federal Reserve System (US Federal Reserve) has an extremely respectable reputation of fighting inflation, they are called “inflation hawks”. These “hawks” immediately attack the inflation as soon as they see it. Unfortunately, this is more difficult for us, because for many years the NBU has been like an “appendix” to the Ministry of Finance. And we had already seen the periods of hyperinflation. To ensure independence and keep inflation under control, the systemic reforms have begun in the NBU just in 2014.

AF: Recently we spoke to Oleksiy Blinov from Alfa Bank. He said that Ukrainians have a stereotype that inflation of 10% is the norm, and they think that if inflation is lower, then somebody is lying.

YG: Once the government lied about inflation in Argentina. In fact, inflation was 20%, and they said it was 10%. I think there is no such thing in Ukraine, and no one is lying about it. However, we have had high inflation during the past 30 years. So it is natural that people think that this is a normal state. But this should not be in the future! And, by the way, I would like to admire Valeriya Gontareva and Yakov Smoliy, the previous teams of the NBU, for curbing the inflation. The last year inflation was 5%, and in the scheme of things such stable inflation is their merit. It’s difficult to say, what will happen in the future…

AF: In the penultimate episode of the podcast, we discussed that inflation could accelerate to 10% this year. How good is it for Ukraine in such a crisis year? Taking into account past targets and past restrained fiscal policy. 

YG: Inflation is not the main problem during the crisis. And inflation can be endured. For example, there are discussions in the United States that there will be an inflation. But in reality the inflation expectations are at the level of 2-2.5%. Because the Federal Reserve System has an extremely strong reputation. They said they could allow slightly higher inflation this or next year. But if inflation rises, they will fight it. And they will never allow inflation of 5% or 10%, as it was in the 70s or 80s. As people believe the FRS’s claims, inflation expectations have not risen. 

We have a more complicated problem because there are no stable inflation expectations. If people have always seen 10% inflation over the last 30 years, it is difficult to expect inflation to be low this year or next. Yes, of course, we can allow a little more inflation to help the economy. But the long-term costs will be much higher. Why? The NBU has made a lot of efforts to curb inflation, to reduce it to 5% since 2014, and now we are inflating it again to 10%. In such a way the next time no one will believe when we promise 5% for the coming years. Therefore, we will have to “tighten belts” again, raise interest rates, push the economy into recession in order to curb inflation. So, I don’t think that inflation at 10% is the optimum alternative for Ukraine. 

AF: We are very actively discussing the question, whether we should raise taxes during the crisis. The questions about payment transactions recorders and unshadowing of the economy, impact of the tax burden on business, raising the minimum wage as an additional hidden tax for business were discussed. Is the United States discussing the tax increases now?

YG .: There are no plans to raise taxes now, and there is no such discussion. Now it is very difficult to promote something in Congress, especially if to talk about the tax increase. As this requires a super majority in the Senate, and the Democrats do not have it. However, it seems to me that in the future taxes will be increased, the only question is how.

The increase of the minimum wage is being discussed in both Ukraine and the United States. It may be done mainly with the help of unshadowing, rise of budget income in Ukraine. And it is more a matter of inequality and helping low-income people in the United States. In the United States, this offer was even originally in Biden’s “aid package”, but it did not pass in the Senate. Because people have realized that now is not the time to raise the minimum wage. It is not clear to me why it is necessary to raise the minimum wage in Ukraine now, when the economic situation is extremely difficult.

How will US policy affect the world economy?

AF: The question, that worries everyone, when inflation rises. What will be the dollar exchange rate and how much will a rent house or a minimum set of products cost? How will the stimulus packages in the United States impact on the global economy and different markets? How will Ukrainians feel the impact of Americans support?

YG: Let’s start with the fact that the USA is a locomotive of the world economy. At some time, it was only the United States, now it is also China. But, in any case, the USA is a leading economy for the Western world. If everything goes well in the States, then everywhere everything goes well. Why will it be good for Ukraine? Because we export to the USA and Europe. And if the States grows, they will consequently buy our goods. If the United States grows, Europe will also grow and, again, buy more Ukrainian goods.

On the other hand, if the United States grows rapidly, at some point the interest rates will go up, and then Ukraine will have to pay a higher price for its debts. Rising energy prices – oil and gas – can also be a problem for us. How big it will be a problem – time will tell. I think that interest rates are not a question of this year, but rather of 2022-2023. And energy prices are something that needs to be carefully monitored now.

YM: Now the United States will borrow more, and interest rates on their bonds will rise. Can we expect some investors to go from countries like Ukraine to US securities? Or if our rates are still higher than in the US, will they stay with us? 

YG: Financial markets are extremely integrated. When Ukraine borrows on world markets, our competitors are the whole world, the United States, Indonesia, Egypt, Morocco and others. There are a lot of those who want to borrow. Now Ukraine pays extremely low interest rates because the interest rates are kept to a minimum in the whole developed world. And in order to earn at least some money, investors are ready to take big risks. For example, to invest in Ukraine or Egypt or other developing countries. But when the period of normalization comes, when the economies in the Western world stabilize and begin to grow, the interest rates will also begin to rise. Then investors will invest in less risky countries. Interest rates will rise for Ukraine, and it will be much more difficult to borrow. We need to start preparing for this now: to restructure the debts, to establish cooperation with the IMF. Because for some time we will have to take a lot of debt to make payments by previous debts. We need to work to ensure that new debts would not be too expensive.

Forecasts for 2021: coming back to normalcy?

AF: What are your predictions for this year? How will this recovery meet the expectations that exist? The fall from quarantine restrictions was lower than expected in Ukraine. And in general, this pandemic set a lot of expectations, which were not so terrible.

YM: They’re  still terrible, we have just fallen not at 8%, but at 4%.

YG: There is a macroeconomic aspect, and a health care aspect. If we curb the virus, everything will be fine: economic growth, investment and consumption – everything will work. If you look at the United States, the tempo of vaccination is extremely fast. Biden promised that it will be possible to meet friends, family and have a normal life from Independence Day, July 4. I would very much like to hope that on Ukrainian Independence Day we will be able to do the same. So that people are not afraid of contracting the virus, so that they have freedom of movement, can go to cinemas and shops, so that normal life can be restored. Will Ukraine be able to do that? Time will show. The third wave of coronavirus is already underway. Kyiv is being closed… it seems to me from Saturday (March, 20)?

YM: Yes. And vaccination is slow.

YG: Yes. The situation with the virus creates uncertainty, that cannot be solved with the help of macroeconomic measures. This should be solved only with the help of medical measures.

AF: It turns out that there will be an increase of inequality. There are countries that get vaccinated faster and recover faster, and those that get stuck in permanent quarantines and restrictions. 

YG: That’s right.

YM: But we’ll talk about that in the next podcast episode.