Category: Economics: Ch 26

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The Russian economy after four years of war

At the fourth anniversary of Russia’s invasion of Ukraine, we look at the effect of the war on the Russian economy. Two years ago, in the blog The Russian economy after two years of war, we argued that the Russian economy had seemingly weathered the war successfully.

Unlike Ukraine, very little of its infrastructure had been destroyed; it had started the war with a current account balance of payments surplus, a budget surplus and a low general government debt-to-GDP ratio; it had achieved a lot of success in diverting its exports, including oil, away from countries imposing sanctions to countries such as China and India; it was the same with imports, with China especially becoming a major suppliers of machinery, components and vehicles; it has a strong central bank, which engenders a high level of confidence in managing inflation; the military expenditure provided a Keynesian boost to the economy, with production and employment rising.

The situation today

But two years further on, the Russian economy is looking a lot weaker and on the verge of recession. GDP growth fell to 0.6 per cent in 2025 and is forecast to be no more than 1 per cent for the next two years. (Click here for a PowerPoint of the chart.) And despite growth still being positive (just), this is largely because of the growth in military expenditure. Retail and wholesale trade fell by 1.1% in 2025, reflecting supply chain problems and high inflation dampening consumer demand.

With labour being diverted into the armaments and allied industries or into the armed forces, this has led to labour shortages. This has been compounded by the emigration of up to 1 million people by 2025 – often young, educated and skilled professionals.

Official CPI inflation averaged 8.7 per cent in 2025, although the prices of food and other consumer essentials rose by more, especially in recent months. At the beginning of 2026, supermarket prices rose by 2.3% in just one month, made worse by a rise in VAT from 20% to 22%. The central bank has responded to the high inflation with high interest rates, which averaged 19.2% in 2025, giving a real rate of 10.5%. With such a high real rate, the response of households has been to save. This has masked the constraints on production, or imports, of consumer goods. Savings have also been boosted by large payments to soldiers and bereaved families, with the money saved by the recipients being used in part to fund future such payments. So far there has been trust in the banking system, but if that trust waned and people starting making large withdrawals of savings, it could be seriously destabilising.

Whilst the high real interest rates have helped to mask shortages of consumer goods, they have had a seriously dampening effect on investment by domestic companies. Gross capital formation fell by 3% in 2025, not helped by an increase in the corporation tax from 20% to 25%. At the same time, foreign direct investment remains subdued due to high perceived risks. The lack of investment, plus the labour shortages, will have profound effects on the supply side of the economy, with potential output in the non-military sector likely to decline over the medium term.

The balance of payments and government finances are turning less favourable. The balance of trade surplus has declined from US$173bn in 2021 to US$67bn in 2025. This could decline further, or even become a deficit, if oil prices continue to be weak, if Western sanctions are tightened (such as stopping the flow of Russian oil exports in the ‘shadow’ fleet of tankers) or if major importing countries stop buying Russian oil. Indian refiners have announced that they are not taking Russian crude in March/April as India seeks to finalise a trade deal with the USA.

The budget balance has moved from a small surplus of 0.8% of GDP in 2021 to a deficit of 2.9% in 2025. Although the government debt-to-GDP ratio remains low by international standards at 23.1% of GDP in 2025, this was up from 16.5% in 2021 and is set to rise further as budget deficits deepen. Nevertheless, as long as the saving rate remains high, the debt can be serviced by domestic bond purchase.

Russia’s economy is definitely weakening and labour shortages and low investment will create major problems for the future. But whether this deterioration will be enough to change Russia’s stance on the war in Ukraine remains to be seen.

Articles

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Reports

Data

Questions

  1. What constraints are there currently on the supply side of the Russian economy?
  2. Some economists have argued that the economic effects of a stalemate in the Ukraine war would suit the Russian leadership more than peace or victory. Why might this be so?
  3. Under what circumstances might a deep recession in Russia be more likely than stagnation?
  4. In what ways does Russia’s current financial system resemble a pyramid scheme?
  5. What cannot a Keynesian boost contunue to support the Russian economy indefinitely?
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Who pays Trump’s tariffs?

Three recent reports (see links below) have suggested that US consumers and businesses pay most of the tariffs imposed by the second Trump administration. The percentage varies from around 86% to 96%. US customs revenue surged by approximately $200 billion in 2025, but this was a tax paid almost entirely by US consumers and businesses. Foreign suppliers largely maintained their (pre-tariff) prices. They took a hit in terms of reduced volumes rather than reduced pre-tariff prices.

The incidence of a tariff between consumers, domestic importers and overseas producers will depend on price elasticities of demand and supply. The following diagram shows a product where the importing country is large enough to have a degree of market power, which will normally be the case with the USA. The greater its buying power, the flatter will be its demand curve, showing that the foreign supplier will have little influence on the price. With no tariff, the equilibrium price paid by importers will be at point a, where demand equals supply. Q1 would be imported at a price of P1.

Imposition of a tariff will shift the supply curve upwards by the amount of the tariff. The new equilibrium price paid by importers will be at point b, where the new supply curve crosses the demand curve. Importers thus now pay a post-tariff price of P2: an effective rise in price of P2 minus P1. Foreign exporters receive P3, which is what they are paid by importers after the tariff has been paid.

The consumer price will be above P2 as that includes a mark-up by US businesses on top of the price they pay to import the product. Importers may bear some of the increase in price and not pass the full amount onto consumers, depending on competition and their ability to absorb cost increases.

President Trump argued that there would be very little rise in price from the tariffs and that overseas suppliers would bear the brunt of the tariffs. Indeed, recently he has argued that this must be the case as US inflation has been falling. In response, critics maintain that the rate of inflation would have fallen more without the tariffs and that current prices would be lower than they are. Also, if US importing firms or retailers bear some of the increased cost, even though this helps to dampen the price rise, their lower profits could damage investment and employment.

The Reports

The first report is from the New York Fed (one of the regional branches of the Federal Reserve Bank). It examines the effect of tariffs imposed in 2025, over three periods: (i) January to August, (ii) September to October, and (iii) November. In the first period, 94% of the tariffs were paid by US importers and 6% by foreign exports; in the second period, the figures were 92% and 8% and in the third period, 86% and 14%.

The second report is The Budget and Economic Outlook: 2026 to 2036 from the Congressional Budget Office. Box 2-1 notes that, as of November 2025, ‘the effective tariff rate was about 13 percentage points higher than the roughly 2 percent rate on imports in 2024’. Its analysis suggests that 95% of the tariffs will be borne by importers. Of these higher import prices, 30% will be borne by US businesses, largely through reduced profit margins, and 70% by consumers through higher prices. This will also allow many businesses which produce goods that compete with foreign imports to ‘increase their prices because of the decline in competition from abroad and the increased demand for tariff-free domestic goods’.

The third report is from the Kiel Insitut. In its Policy Brief, Americaʼs Own Goal: Who Pays the Tariffs?, it finds that US importers and consumers bear 96% of the cost of the 2025 tariffs, with foreign exporters absorbing only about 4%. It bases it findings on shipment-level data covering over 25 million transactions valued at nearly $4 trillion. This also shows that exports to the USA declined as foreign exporters preferred to reduce volumes rather than absorbing the tariffs.

The tariffs raised some $200 billion in 2025, around 3.8% of Federal tax receipts. But, as we have seen, this was paid largely by US consumers and business. It goes some way to offsetting the annual cut in tax revenues of around $450 to $520 billion per year from the tax cuts, largely to the better off, in Trump’s ‘One Big Beautiful Bill’.

Reports

Aricles

Questions

  1. Summarise the findings of the three reports (but just Box 2-1 of the Congressional Budget Office one).
  2. Assess the argument that protectionism leads to inefficiency in the protected industries.
  3. Under what circumstances would exporters to the USA absorb a high percentage of tariff increases? Consider questions of elasticity.
  4. Can tariffs ever be justified on efficiency grounds?
  5. Can tariffs be justified as a bargaining ploy? Can they be used as a means of achieving freer and fairer trade?
  6. Read the blog, President Reagan on tariffs and summarise President Reagan’s arguments. Are they still relevant today?
  7. Consider the arguments for and against the EU raising tariffs on US goods.
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The precious metals roller coaster

Precious metals, such as gold, silver and platinum, are seen as safe havens by investors in uncertain times. With the on-off nature of Donald Trump’s tariffs, with ongoing wars, such as the war in Ukraine, and with threats of US action in Iran, with inflation slow to fall and pressure by the Trump administration on the Federal Reserve to make precipitant cuts in interest rates, investors have flocked to precious metals.

Precious metals peaked in late January 2026. Compared with just four months earlier, gold was up by 48%, platinum by 76% and silver by a massive 162%. Silver and platinum were also boosted by their industrial uses. Silver has excellent conductive properties and is used for electronics, AI, solar energy (photovoltaic cells), chemical catalysts and medical equipment. Over 50% of its consumption is for industrial purposes. Platinum is used as a catalyst in catalytic converters to reduce exhaust emissions, in medical devices, chemical processing, oil refining, electronics and glass manufacturing.

The rise was fuelled by speculation, which gathered momentum in December and January. But then the prices of all three metals fell dramatically on Friday 30 January and a bit more on 2 February. Despite a moderate bounce back on 3 February, the prices then fell again and by the end of 5 February, gold had fallen by 15%, platinum by 30% and silver by a massive 42% from the peak.

Figure 1 illustrates the effect of speculation on the rise in price of a precious metal, such as silver. Assume that demand rises from D0 to D1 for the reasons given above. Equilibrium moves from point a to point b and the price rises from P1 to P2. Seeing the price rising, holders of the metal wait until the price rises further before selling. Supply shifts from S1 to S2. Potential purchasers of the metal, anticipating a further rise in price, buy now before the price does rise. Demand shifts from D1 to D2. As a result, equilibrium moves from point b to point c and price rises to P3.

Figure 2 illustrates the effect of speculation on the subsequent fall in prices triggered by a belief that price will fall. Speculative selling shifts the supply curve from S2 to S3. Potential demanders hold back and the demand curve shifts from D2 to D3. Equilibrium moves to point d and price falls from P3 to P4. (Click here for a PowerPoint of the two figures.)

But why did prices fall so dramatically? The first reason was that analysts were beginning to argue that the exuberance of investors had led the price of all three metals to overshoot the fundamental balance of supply and demand. Once a tipping point arrived, people sold quickly to lock in the gains they had made over previous weeks. This profit taking caused prices to plummet as speculation of further falls drove prices lower.

So what was the tipping point? This was the appointment by Donald Trump of Kevin Warsh as the new Chair of the Federal Reserve to take over from Jerome Powell when his tenure comes to an end in May this year.

It was expected that Trump would appoint someone much more willing to cut interest rates and this worried investors, who feared that inflation would rise again. This uncertainty drove demand for precious metals, which are seen as a safe haven. But Kevin Walsh is viewed as hawkish on monetary policy and less likely to slash interest rates than other possible choices for Chair. This triggered the fall in precious metal prices.

But the main factors that drove the demand for the metals still exist. There is still uncertainty, still an increased demand from central banks for gold, still a growing demand for silver and platinum for industrial uses. The next day, 3 February, it seemed that the prices of all three metals had over-corrected. Investors started buying again at the lower prices and consequently prices rose again – once more fuelled by speculation. Gold rose by 6.1%, platinum by 7.9% and silver by 11.6%.

Articles

Data

Questions

  1. What has happened to the price of silver since this blog was written? Use a demand and supply diagram to illustrate this.
  2. Identify the factors that affect the demand for and supply of (a) silver; (b) gold.
  3. What determines the elasticity of supply of silver (a) in total; (b) to the market?
  4. Choose another commodity other than the three metals considered in this blog. Find out what has happened to their prices over the past 12 months and explain why these price movements have occurred.
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Fed independence under attack

Donald Trump is keen to lower US interest rates substantially and rapidly in order to provide a boost to the US economy. He is also keen to reduce the cost of living for US citizens and sees lower interest rates as a means of reducing the burden of debt servicing for both consumers and firms alike.

But interest rates are set by the US central bank, the Federal Reserve (the ‘Fed’), which is formally independent from government. This independence is seen as important for providing stability to the US economy and removing monetary policy from short-term political pressures to cut interest rates. Succumbing to political pressures would be likely to create uncertainty and damage long-term stability and growth.

Yet President Trump is pushing the Fed to lower interest rates rapidly and despite three cuts in a row of 0.25 percentage points in the last part of 2025 (see chart below), he thinks this as too little and is annoyed by suggestions that the Fed is unlikely to lower rates again for a while. He has put great pressure on Jerome Powell, the Fed Chair, to go further and faster and has threatened to replace him before his term expires in May this year. He has also made clear that he is likely to appoint someone more willing to cutting rates.

The Federal Reserve headquarters in Washington is currently being renovated. The nine-year project is costing $2.5 billion and is due to be completed next year. President Trump has declared that the project’s costs are excessive and unnecessary.

On 11 January, Federal prosecutors confirmed that they were opening a criminal investigation into Powell, accusing him of lying to Congress in his June 2025 testimony regarding the scope and costs of the renovations.

Powell responded by posting a video in which he claimed that the real reason that he was being threatened with criminal charges was not because of the renovations but because the Fed had ignored President Trump’s pressure and had set interest rates:

based on our best assessment of what will serve the public, rather than following the preferences of the President. This is about whether the Fed will be able to continue to set interest rates based on evidence and economic conditions – or whether, instead, monetary policy will be directed by political pressure or intimidation.

The Fed’s mandate

The Federal Reserve Board decides on monetary policy and then the Federal Open Market Committee (FOMC) decides how to carry it out. It decides on interest rates and asset sales or purchases. The FOMC meets eight times a year.

The Fed is independent of both the President and Congress, and its Chair is generally regarded as having great power in determining the country’s economic policy.

Since 1977, the Fed’s statutory mandate has been to promote the goals of stable prices and maximum employment. Because of the reference to both prices and employment, the mandate is commonly referred to as a ‘dual mandate’. Its inflation target is 2 per cent over the long run with ‘well anchored’ inflationary expectations.

The dual mandate is unlike that of the Bank of England, the European Central Bank, the Bank of Japan and most other central banks, which all have a single key mandate of achieving a target of a 2 per cent annual rate of consumer price inflation over a particular time period.

With a dual mandate, the two objectives may well conflict from time to time. Moreover, changes in monetary policy affect these objectives with a lag and potentially over different time horizons. Hence, an assessment may have to be made of which is the most pressing problem. This does give some leeway in setting interest rates somewhat lower than if there were a single inflation-rate target. Nevertheless, the assessment is in terms of how best to achieve the mandate and not to meet current political goals.

Statement by former Fed Chairs and Governors

On 12 January, three former Chairs of the Federal Reserve (Janet Yellen, Ben Bernanke and Alan Greenspan), four former Treasury Secretaries (Timothy Geithner, Jacob Lew, Henry Paulson and Robert Rubin) and seven other top former economic officials issued the following statement (see Substack link in the Articles section below):

The Federal Reserve’s independence and the public’s perception of that independence are critical for economic performance, including achieving the goals Congress has set for the Federal Reserve of stable prices, maximum employment, and moderate long-term interest rates. The reported criminal inquiry into Federal Reserve Chair Jay Powell is an unprecedented attempt to use prosecutorial attacks to undermine that independence. This is how monetary policy is made in emerging markets with weak institutions, with highly negative consequences for inflation and the functioning of their economies more broadly. It has no place in the United States whose greatest strength is the rule of law, which is at the foundation of our economic success.

Response of investors

What will happen to the dollar, US bond prices, share prices and US inflation, and what will happen to investment, depends on how people respond to the threat to the Fed’s independence. Initially, there was little response from markets, with investors probably concluding that President Trump is unlikely to be able to sway FOMC members. What is more, several Republican lawmakers have begun criticising the Trump administration’s criminal investigation, making it harder for the President to influence Fed decisions.

Even if Powell is replaced, either in the short term or in May, by a chair keen to pursue the Trump agenda, that chair will still be just one of twelve voting members of the FOMC.

Seven are appointed by the President, but serve for staggered 14-year terms. Four have been appointed by President Trump, but the other three were appointed by President Biden, although one – Lisa Cook – is being indicted by the Supreme Court for mortgage fraud, with the hearing scheduled for January 21. She claims that this is a trumped-up charge to provide grounds for removing her from the Fed. If she is removed, President Trump could appoint a replacement minded to cut rates.

The other five members include the President of the New York Fed and four of the eleven other regional Fed Presidents serving in rotation. These four are generally hawkish and would oppose early rate cuts.

Thus it is unlikely that President Trump will succeed in pushing the Fed to lower interest rates earlier than they would have done. For that reason, markets have remained relatively sanguine.

Nevertheless, Donald Trump’s actions could well cause investors to become more worried. Will he try to find other ways to undermine the Fed? Will his actions over Venezuela, Cuba, Greenland and Iran, let alone his policies towards Ukraine and Russia and towards Israel and Gaza, heighten global uncertainty? Will his actions towards Venezuela and his desire to take over Greenland embolden China to attempt to annex Taiwan, and Russia to continue to resist plans to end the war in Ukraine or to make stronger demands?

Such developments could cause investor confidence to wane and for stock markets to fall. Time will tell. I think we need a crystal ball!

Videos

Articles

Questions

  1. What are the arguments for central bank independence?
  2. What are the arguments for control of monetary policy by the central government?
  3. Assess the above arguments.
  4. Find out what has happened to interest rates, the US stock market and the dollar since this blog was written.
  5. How do the fiscal decisions by government affect monetary policy?
  6. Compare the benefits of the dual mandate system of the Fed with those of the single mandate of the Bank of England and ECB.
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Will AI make the world less equal?

With businesses increasing their use of AI, this is likely to have significant effects on employment. But how will this affect the distribution of income, both within countries and between countries?

In some ways, AI is likely to increase inequality within countries as it displaces low-skilled workers and enhances the productivity of higher-skilled workers. In other ways, it could reduce inequality by allowing lower-skilled workers to increase their productivity, while displacing some higher-skilled workers and managers through the increased adoption of automated processes.

The effect of AI on the distribution of income between countries will depend crucially on its accessibility. If it is widely available to low-income countries, it could significantly enhance the productivity of small businesses and workers in such countries and help to reduce the income gap with the richer world. If the gains in such countries, however, are largely experienced by multinational companies, whether in mines and plantations, or in labour-intensive industries, such as garment production, few of the gains may accrue to workers and global inequality may increase.

Redistribution within a country

The deployment of AI may result in labour displacement. AI is likely to replace both manual and white-collar jobs that involve straightforward and repetitive tasks. These include: routine clerical work, such as data entry, filing and scheduling; paralegal work, contract drafting and legal research; consulting, business research and market analysis; accounting and bookkeeping; financial trading; proofreading, copy mark-up and translation; graphic design; machine operation; warehouse work, where AI-enabled warehouse robots do many receiving, sorting, stacking, retrieval, carrying and loading tasks (e.g. Amazon’s Sequoia robotic system); basic coding or document sifting; market research and advertising design; call-centre work, such as enquiry handling, sales, telemarketing and customer service; hospitality reception; sales cashiers in supermarkets and stores; analysis of health data and diagnosis. Such jobs can all be performed by AI assistants, AI assisted robots or chat bots.

Women are likely to be disproportionately affected because they perform a higher share of the administrative and service roles most exposed to AI.

Workers displaced by AI may find that they can find employment only in lower-paid jobs. Examples include direct customer-facing roles, such as bar staff, shop assistants, hairdressers and nail and beauty consultants.

Such job displacement by AI is likely to redistribute income from relatively low-skilled labour to capital: a redistribution from wages to profits. This will tend to lead to greater inequality.

AI is also likely to lead to a redistribution of income towards certain types of high-skilled labour that are difficult to replace with AI but which could be enhanced by it. Take the case of skilled traders, such as plumbers, electricians and carpenters. They might be able to use AI in their work to enhance their productivity, through diagnosis, planning, problem-solving, measurement, etc. but the AI would not displace them. Instead, it could increase their incomes by allowing them to do their work more efficiently or effectively and thus increase their output per hour and enhance their hourly reward. Another example is architecture, where AI can automate repetitive tasks and open up new design possibilities, allowing architects to focus on creativity, flexibility, aesthetics, empathy with clients and ethical decision-making.

An important distinction is between disembodied and embodied AI investment. Disembodied AI investment could include AI ‘assistants’, such as ChatGPT and other software that can be used in existing jobs to enhance productivity. Such investment can usually be rolled out relatively quickly. Although the extra productivity may allow some reduction in the number of workers, disembodied AI investment is likely to be less disruptive than embodied AI investment. The latter includes robotics and automation, where workers are replaced by machines. This would require more investment and may be slower to be adopted.

Then there are jobs that will be created by AI. These include prompt engineers, who develop questions and prompt techniques to optimise AI output; health tech experts, who help organisations implement new medical AI products; AI educators, who train people in the uses of AI in the workplace; ethics advisors, who help companies ensure that their uses of AI are aligned with their values, responsibilities and goals; and cybersecurity experts who put systems in place to prevent AI stealing sensitive information. Such jobs may be relatively highly paid.

In other cases, the gains from AI in employment are likely to accrue mainly to the consumer, with probably little change in the incomes of the workers themselves. This is particularly the case in parts of the public sector where wages/salaries are only very loosely related to productivity and where a large part of the work involves providing a personal service. For example, health professionals’ productivity could be enhanced by AI, which could allow faster and more accurate diagnosis, more efficient monitoring and greater accuracy in surgery. The main gainers would be the patients, with probably little change in the incomes of the health professionals themselves. Teachers’ productivity could be improved by allowing more rapid and efficient marking, preparation of materials and record keeping, allowing more time to be spent with students. Again, the main gainers would be the students, with little change in teachers’ incomes. Other jobs in this category include social workers, therapists, solicitors and barristers, HR specialists, senior managers and musicians.

Thus there is likely to be a distribution away from lower-skilled workers to both capital and higher-skilled workers who can use AI, to people who work in new jobs created by AI and to the consumers of certain services.

AI will accelerate productivity growth and, with it, GDP growth, but will probably displace workers faster than new roles emerge. This is likely to increase inequality and be a major challenge for society. Can the labour market adapt? Could the effects be modified if people moved to a four- or three-day week? Will governments introduce statutory limits to weekly working hours? Will training and education adapt to the new demands of employers?

Redistribution between countries

AI threatens to widen the global rich–poor divide. It will give wealthier nations a productivity and innovation edge, which could displace low-skilled jobs in low-income nations. Labour-intensive production could be replaced by automated production, with the capital owned by the multinational companies of just a few countries, such as the USA and China, which between them account for 40% of global corporate AI R&D spending. For some companies, it would make sense to relocate production to rich countries, or certain wealthier developing countries, with better digital infrastructure, advanced data systems and more reliable power supply.

For other companies, however, production might still be based in low-income countries to take advantage of low-cost local materials. But there would still be a redistribution from wages in such countries to the profits of multinationals.

But it is not just in manufacturing where low-income countries are vulnerable to the integration of AI. Several countries, such as India, the Philippines, Mexico and Egypt have seen considerable investment in call centres and IT services for business process outsourcing and customer services. AI now poses a threat to employment in this industry as it has the potential to replace large numbers of workers.

AI-related job losses could exacerbate unemployment and deepen poverty in poorer countries, which, with limited resources, limited training and underdeveloped social protection systems, are less equipped to absorb economic and social shocks. This will further widen the global divide. In the case of embodied AI investment, it may only be possible in low-income countries through multinational investment and could displace many traditional jobs, with much of the benefit going in additional multinational profit.

But it is not all bad news for low-income countries. AI-driven innovations in healthcare, education, and agriculture, if adopted in poor countries, can make a significant contribution to raising living standards and can slow, or even reverse, the widening gap between rich and poor nations. Some of the greatest potential is in small-scale agriculture. Smallholders can boost crop yields though precision farming powered by AI; AI tools can help farmers buy seeds, fertilisers and animals and sell their produce at optimum times and prices; AI-enabled education tools can help farmers learn new techniques.

Articles

Questions

  1. What types of job are most vulnerable to AI?
  2. How will AI change the comparative advantage of low-income countries and what effect will it be likely to have on the pattern of global trade?
  3. Assess alternative policies that governments in high-income countries can adopt to offset the growth in inequality caused by the increasing use of AI.
  4. What policies can governments in low-income countries or aid agencies adopt to offset the growth in inequality within low-income countries and between high- and low-income countries?
  5. How might the growth of AI affect your own approach to career development?
  6. Is AI likely to increase or decrease economic power? Explain.