Having seen the immediate and not so immediate policy responses to the financial crisis it is time to address a deeper and – potentially – more disturbing question. In November 2008 Her Majesty the Queen was visiting the London School of Economics and reportedly asked a question that has since become famous and very, very relevant: “How come you didn't see it coming?” Where obviously she was addressing professional economists and financial experts at that institution. This question has given rise to several answers. Some economists (Besley & Hennessy 2009) put together a written response to Her Majesty, explaining what had happened and why it was not seen coming. This can be summarized as everybody doing the right thing, but the crisis was a one-off shock or an unforeseen and unforeseeable event. Any such answer appears obviously to have the aim of absolving both the policymakers in charge at the time and the theoretical models on which policies were formulated.

Other people, including prominent economists who have been at the very centre of policymaking, have taken a very different view, by claiming there had been something wrong about the policies being pursued and also about the economic models that were used to justify those policies. A prime example is Buiter, at one stage a member of the monetary policy committee at the Bank of England, who has famously written a very scathing article (Buiter 2009) about the uselessness of a particular type of macro and how it had engendered a sense that a crisis could not happen in the way that instead it did. Another such example would be Krugman who has been a very vocal critic of some macro models and hence the policies predicated on those models being very wrong.

A third set of answers asked the question: can it be that by pursuing the policies typical of the great moderation, an environment that actually fostered financial instability was put in place that eventually erupted in the financial crisis? Otherwise put, could it be that there is a trade-off between inflation targeting and financial stability? It is this kind of argument to which this chapter is dedicated with the first example being an adaptation of a diagram developed by De Grauwe (2012: 201) in his textbook on the economics of monetary union.

Until now hints have been given that fiscal policy needed to be looked into, but nothing has been done about it. The reason for not doing so until now is that, to an extent, Carlin and Soskice (2006, 2014) and other textbooks have followed what was an established consensus, and what has been described as a consensus assignment that applied before the financial crisis. This consensus assignment rested on two propositions: (a) stabilization of inflation and output was the task of monetary policy, and it was for the central bank to deal with such matters in the way described in the preceding chapters, whereas fiscal policy could not be used as a countercyclical tool, in order to stabilize output over the cycle; (b) the purpose of fiscal policy was instead to stabilize the ratio of government debt to GDP, for reasons that will be detailed below. A number of arguments were used to justify the preference for monetary policy as a stabilization tool. In the first instance, there was the undeniable fact that fiscal policy acts with longer lags, and it takes a much longer period of time to be implemented, because legislation will have to be passed for new taxation rates, and new levels of expenditure. All this takes time and the implementation thereof will take longer still, whereas changing the interest rate, which is the main tool of monetary policy, as it was before the financial crisis, takes very little. It may take time to feed through and have the desired effect on output and inflation as detailed before, but in terms of the actual policy change the delay can be deemed to be much shorter than it is the case with fiscal policy. The second obvious reason that could be deemed to be relevant in the context of a small open economy, is the fact that assuming a Mundell-Fleming model, or a variation thereof, provided that the exchange rate regime be a flexible one, it is only monetary policy that is effective at changing output, whereas fiscal policy should be completely ineffective.

As stated before, the three-equations model synthetically presented in the previous chapter, is intended to be many things with the obvious aim of being a less obsolete framework to represent modern policy choices than the venerable IS-LM. That is, however, not the only aim, because the other obvious one is to be a pedagogically accessible, diagrammatic representation of the model most central banks and treasury departments use for their forecasting. This model is known as the dynamic stochastic general equilibrium one (DSGE), but also sometimes as the “consensus model” because it represents a way in which the great disagreement in macroeconomic modelling originating from the 1980s came to a consensus representation in that the main structure of the real business cycle agenda (also known as fresh-water economics as it is mainly associated with the universities on the great lakes of the United States) was paired with key insights originating from New Keynesian economics (also known as salt-water economics as it is mainly associated with the universities on the two coasts of the United States). There are many versions of the DSGE and therefore any generalization on this is bound to be easily disproven, but very superficially the model is often summarized into three basic equations. These are:

• 1. An interest rate rule (or Taylor rule) that describes the behaviour of the policymaker which is obviously the equivalent of the monetary rule of the previous chapter.

• 2. A demand-side equation sometimes described as a New Keynesian IS curve (which is obviously meant to match the IS curve of the previous chapter).

• 3. A supply-side equation of different and varied specification that may take the form of the New Keynesian Phillips curve whose function is performed by the inertiaaugmented Phillips curve of the previous chapter.

Again very superficially, because there are three equations matched by another three, it would be easy to claim that the two models must be pretty much interchangeable. That is, however, not true the moment one digs deeper into how the three relationships are justified in the two models. The task of the present and following chapter is therefore to explore what lies behind the three equations presented in the previous one, and understand the extent to which they actually depart from the corresponding ones of the DSGE they so superficially match.

Until now expectations on inflation have been formed with a mechanical rule whereby the past realized inflation rate is used as the best prediction of the next period one so that in symbols: πte= πt−1. The reasons for adopting such a simple rule are primarily empirical. As Carlin and Soskice (2006, 2014) argue, it is a specification that fits the data well over the period of the great moderation and it captures the empirical observation of a certain inertia in inflation, whereby the current rate of inflation in any one period has a bearing on what the next period's rate of inflation can be. Assuming that households and firms operate under such a rule has a certain plausibility, provided that the general context in which expectations are formed be a relatively stable one. These conditions are obviously matched in the sample period of the great moderation and it is therefore plausible to imagine that many economic agents would resort to such a simple mechanical rule, or collectively act as if they had adopted such a rule, when the actual oscillations of the inflation rate around the target rate are too minimal to warrant more informed and more costly assessments of what is to be expected. Nonetheless there is no denying that the adoption of such a mechanical rule has serious theoretical drawbacks that largely match what prompted the abandonment of the adaptive expectations mechanism in the 1970s. In practice, there is in fact little way of discriminating between the inertial specification of the Phillips curve and the one adopted by Friedman (1968) with an adaptive expectations mechanism, whereby expectations are formed on the basis of some update or correction on past forecasting errors. A degree of observational equivalence is inevitable and therefore the theoretical criticisms apply equally. These in particular are the following.

In the first instance, there is a degree of undesirable asymmetry whereby the central bank is forward-looking or is able to predict what is going to happen, in particular the future period inertia-augmented Phillips curve, whereas firms and households are entirely backward-looking and are reacting to past events rather than looking forward to forthcoming ones.

The legacy of the Mundell-Fleming model

Until now an assumption has been made that the economy under consideration is a closed one, and is therefore not open to international trade and international flows of finance. This is deeply implausible especially when the actual economy being considered is that of the UK, or of any individual country in Europe. In practice, the choice of maintaining the economy closed in its modelling is dictated by the fact that abandoning the LM curve has very awkward implications for an open economy model, which has to replicate the results of the venerable Mundell-Fleming one. The latter can be described as the open economy extension of the IS-LM, but translating it into a diagram that would dispense with an LM curve that represents changes in the domestic money supply has proven a challenge. In their 2006 book, Carlin and Soskice shied away from such a challenge and reverted to the Mundell-Fleming in their open economy chapters, thereby reinstating the implausible LM curve. This was altered in the 2014 book (Carlin & Soskice 2014) but, as it will be argued below, the result is not altogether satisfactory. The unavoidable challenge is given by the fact that the Mundell-Fleming diagram is invariably simpler and more intuitive than any of its replacements. So, it comes to a choice: textbooks (e.g., Gärtner 2014) which place the treatment of the open economy at their centre, opt to retain that older model at the price of an implausibly obsolete diagrammatic representation of the conduct of monetary policy. Textbooks instead that place greater weight on a plausible and accurate description of the latter, have to compromise with awkward diagrams in their open economy settings. This is the route taken by Carlin and Soskice (2014) and so will it be the case in what follows here, in the hope of doing something marginally less awkward. But it has to be understood that the aim is to replicate the results of the Mundell-Fleming which have to be kept in mind, and a thoroughly clear rendition of which can be found in Gärtner (2014).

To start, we need to understand why and how the Soviet Union collapsed and how the trauma of collapse shaped how Putin, his allies and millions of Russians came to view the world. Putin described Soviet collapse as “the greatest geopolitical catastrophe of the century”. “Tens of millions of our fellow citizens and countrymen found themselves beyond the fringes of Russian territory”. An “epidemic of collapse” as he called it, spilled into Russia, threatening its very existence. The 1990s are remembered as a traumatic time for most Russians in which quality of life and rule of law fell apart. Savings and job security evaporated. Rates of poverty, alcoholism and mortality increased. Average life expectancy fell by nearly five years. Russia's population declined. Putin came to power as prime minister at the end of that turbulent decade in 1999 and became president the following year. His presidency was defined by that backdrop; Putinism was all about reversing that catastrophe and restoring Russian pride by rebuilding the state to its former glory. What that meant exactly evolved over time, but Putinism always held Russia of the 1990s as its antithesis. Humiliation, decay, poverty and death are indelibly connected to state weakness, liberalism, democracy, and all things “Western” in the Putinist view of politics.

The collapse of communism sparked violent conflict and Russia used war, and proxies, to protect its interests. The collapse of the USSR unleashed powerful centrifugal forces that Moscow struggled to contain. Even then, Soviet and then Russian governments exhibited an interest in holding onto as much of the USSR as possible, especially those areas where Russians, Russian-speakers, and Russian allies lived, under Moscow's influence. They used force where they could, force moderated principally not by morality or political intent but by crippling incapacity. A will to fight unmatched by the capacity to do so was a recurrent theme, which stretched from Lithuania to the failed August 1991 coup, to Chechnya. Only against the unarmed, the very lightly armed, or other elements of its own enormous military institution did the Soviet and then Russian armies enjoy much success in the 1990s. But it was not for want of trying.

The moment of Putin's failure was caught on a phone's camera. It was Friday 25 February 2022. The phone belonged to Volodymyr Zelensky, president of Ukraine. Rumours that he and his government had fled Kyiv were swirling, fanned by Russian propaganda and trolls, but standing in the lamp-lit street outside his presidential office, Zelensky issued a simple message of defiance. “The PM is here, the Party leader is here, the President is here. We are all here”. He continued, “our military is here. Citizens in society are here. We’re all here defending our country, our independence, and it will stay that way”.

In that moment it was evident that Putin had failed to topple Ukraine's government and replace it with one more subservient to Moscow. In the months and years that followed, Russia also failed to win a decisive military victory capable of coercing Kyiv back into the Eurasian sphere. Russia's naked aggression and Ukraine's heroic defence finally spurred an appalled West into action. Ukrainian forces pushed the Russian army back from Kyiv, Mykolaiv and Kharkiv. The war continues but as I write, Ukraine has conducted a successful counter-offensive in Kharkiv, has retaken the one major city Russian forces did manage to take in its initial advance, Kherson, and has fought Russia's much vaunted spring offensive to a bloody standstill in Bakhmut. Russian losses are colossal. The US estimates that Russia has sustained more than 200,000 casualties. It has lost thousands of tanks, APCs and drones, dozens of helicopters and aircraft. Things have got so bad that in September 2022, Putin was forced to order a general mobilization of men of fighting age, pouring badly trained civilians into the grinder to replace the professional troops eliminated by Ukraine's defenders. Wagner recruited prisoners to send to the front and provided the vanguard for the assault on Bakhmut in spring 2023, its cavalier attitude to the welfare of its soldiers resulting in appalling losses. When Ukraine started to turn the tide there too, Prigozhin launched an excoriating public tirade against Putin and the Russian army, who he blamed for the failure – a telling sign that the Putinist alliance is fracturing under the weight of its own war.

In early 2011, three years before Euromaidan, the Middle East was convulsed by popular uprisings, the Arab Spring. First, Tunisia's long-serving president Zine El Abidine Ben Ali was driven from power. Then, Egypt's Hosni Mubarak, another long-serving authoritarian, was ousted by protestors. The uprising convulsed Libya too, but Muammar Gaddafi turned his guns on peaceful protestors. When the protestors fought back, the country slid into civil war. Prompted by pressure from the Arab world and Europe, the UN Security Council authorized a NATO-led intervention to protect Libyan civilians. Russia abstained in that vote, a bone of contention between its president, Dmitry Medvedev, and prime minister, Putin. Oman, Saudi Arabia, Jordan, Bahrain and Yemen also experienced mass uprisings. The first three used limited political reform and economic incentives to mollify the crowds; the government in Bahrain restored order violently with the help of Saudi military intervention; Yemen careered into civil war.

It was Syria, however, that loomed largest. The uprising there led to a bloody civil war, the rise of the radical jihadist Islamic State (IS), and drew in Iran, Hezbollah, the US, the UK, France, Saudi Arabia, Qatar, Jordan, Turkey and Russia.

Before Crimea, Medvedev and then Putin had steered a course focused on preventing Bashar al-Assad's violent overthrow without direct military intervention. In autumn 2015, however, Putin ordered the Russian military into Syria to prop-up Assad's flagging regime, his position hardened by three considerations: Western timidity which created a vacuum he was happy to fill; fear that Assad faced imminent defeat; and confidence in the capacity of Russian military force to achieve its political goals of defending Assad, extending Russian influence into the Middle East, and forcing the West to acknowledge Russia's great power status by making itself indispensable to peace in Syria. Taking advantage of Western timidity, disunity and confusion, Putin ended Russia's brief post-Crimea diplomatic isolation by positioning itself as the great and indispensable power necessary for peace in Syria. But victory in Syria came at a terrible price: a civil war that consumed more than half a million lives and displaced more than half Syria's pre-war population. The Syrian government and its allies were responsible for around 90 per cent of all civilian deaths, Russian forces alone killed at least 7,000 Syria civilians.

Putin got his small and victorious war. But it came in Georgia, not Chechnya. Russia's August 2008 war in Georgia proved immensely popular at home. With only a modest display of its military might, Russia seemingly achieved all its political objectives. It is ironic, then, that this triumph arrived only after Putin had stepped down as president.

Russia's war with Georgia remains mired in controversy centred on the question of who fired the first shot. The Georgians insist Russia conducted a campaign of destabilization aimed at a creeping annexation of Georgian territories in South Ossetia and Abkhazia. This campaign had its roots in the politics of Soviet collapse but accelerated under Putin. They argue that in the spring and summer of 2008, Russian-backed South Ossetian separatists attacked Georgian villages and security forces and that Russia deployed troops into the disputed territories to support them. Faced with the actualization of creeping annexation, they say, Georgia had little choice but to send its own troops into South Ossetia to hold the country together. The Kremlin claims it intervened to protect the South Ossetians from genocide only after Georgian forces attacked.

To understand what happened and why we need to trace two stories that conjoined. The first is a Georgian story: of its tumultuous separation from the Soviet Union, civil war and authoritarian government. The second is a Russian story: of how the Kremlin attempted to preserve what it called a “zone of privileged interest” in the former-Soviet space, a “liberal empire” to use the terminology employed by Anatoly Chubais, arguably the chief architect of the Yeltsin government's economic reform. Russia's first efforts to control the newly independent governments on its borders were chaotic, but over time they morphed into something more coherent and substantial, a core of Putin's political project. The two stories conjoined in 2003 when Georgia's “Rose Revolution” upended the rule of Eduard Shevardnadze (Gorbachev's long-serving foreign minister turned president of Georgia) and replaced it with that of Mikheil Saakashvili: a democrat (initially), reformist and nationalist. Saakashvili wanted to do two things: drag Georgia out of Russia's sphere and into closer partnership with the West and establish the state's authority over all the country's territory. That put Saakashvili on a collision course with Putin.

A second war in Chechnya made Vladimir Putin, transforming him from anonymous apparatchik supported by just 2 per cent of Russians into an immensely popular president. It allowed him to renegotiate the state's social contract with the people as the media, oligarchs, regional governments and political opposition were brought under the Kremlin's sway in return for the promise of stability. Chechnya convinced Putin and his allies that war could solve political problems. It taught them the power of nationalist mobilization and demonstrated the capacity of military force to reassert Russia's lost authority and re-establish a sense of pride. It reaffirmed the Russian military's belief in the offensive value of overwhelming and indiscriminate firepower. But whilst the rallying around the flag – and the president – was real enough, some effects were mere mirages. Victory in Chechnya was not as decisive as it seemed. Nor was it achieved by Russian military prowess alone. It was Chechnya's Kadyrov clan that finally won the Chechen war, not the Russian army. Chechnya today may be firmly a part of the Russian Federation but it is Ramzan Kadyrov's word that is law there. His is an autonomous Chechen regime – the sort of thing the separatists wanted – propped up by eye-watering amounts of Russian money.

Operation successor

Vladimir Putin left Dresden at the beginning of 1990, apparently gifted an old washing machine by East Germans grateful for his service. Still on the KGB's books as a member of the active reserve, he returned to Leningrad's university where he renewed his friendship with his old professor, Anatoly Sobchak. The city he returned to was very different to the dormant but safe one he had left a few years before. It wasn't just that its name had reverted back to Saint Petersburg. Gorbachev's reforms had brought freedom and a lawless capitalism. Many of the city's first entrepreneurs were violent criminals. As the economy crashed, food became a prized commodity. Hunger was common. Into the void strode criminal gangs, peddling the essentials of life as well as drugs, alcohol, corruption, prostitution and violence. The old Soviet command system was dead but there weren't yet any laws or institutions to govern the new capitalist system. As the weapons of the Red Army followed demobilized soldiers into the marketplace, AK-47s were readily available from car-boots and street stalls.

Vladimir Putin insists Ukraine is not a real country. That its people are really Russians. That its state is not fully sovereign. That its boundaries are historical accidents. Russia's president has said this often. His reasoning evokes such an unadulterated imperialism of earlier centuries it is hard to see how a modern leader could be more overtly imperialist. But it is not just Putin. From what we can tell, many Russians think the same way. When, in the 1990s, Boris Yeltsin's reform-minded foreign minister, Andrei Kozyrev, talked of reintegrating Russia with former Soviet republics, it was Ukraine and Belarus he had in mind. For Kozyrev as for Putin, it was axiomatic that Russia's identity as a great power hinged on a hierarchical relationship with its post-Soviet neighbours, typically referred to as the “near abroad” by Russians to denote that these states were not properly “foreign” or sovereign. Russian control of Ukraine is an article of faith for many Russians, rooted in the idea that Russians and Ukrainians are one people. Held by nationalists, communists, and many liberals, this attitude towards Ukraine plainly exhibits Russia's imperial sense of self.

In the ninth century, adventurous Vikings calling themselves the “Rus” established riverine trade routes between Scandinavia and Byzantium. One of their greatest was on the mighty Dnieper River. A staging post, Kyiv evolved into the centre of a prosperous warrior kingdom. Kyivan Rus expanded over the next couple of centuries, at its peak extending from the Black Sea to the Baltic. In the late tenth century, its ruler, Prince Volodymyr (Vladimir in Russian) converted to Eastern Orthodoxy. Under the leadership of Prince Yaroslav “the Wise”, Kyiv erected its own Santa Sofia cathedral in the eleventh century. Yaroslav's children were less than wise, however. They squabbled and fought internecine wars that divided the territory and weakened themselves.

The end came at the hands of the Mongols in the thirteenth century and it was here that the Rus became two or perhaps three peoples. Russian nationalists claim that when Kyiv fell, the Rus fled north to Muscovy and established there the successor to the Kyivan Rus. Ukrainian nationalists tell a different story, that the Rus remained in Kyiv and founded Ukraine. The truth is lost to history, but most likely some fled, and some stayed. More important was the fact that for the next 400 years, Kyivans and Muscovites lived in different political orbits.

Russia's invasion of Ukraine in late February 2022 caught many people by surprise. It should not have. This was an imperial war long in the making. It was a war that fulfilled the long-held needs and aspirations of Russia's president, his allies and dependents, and a large section of Russian society that had become willing accomplices in and cheerleaders for the state's imperial project. To paraphrase the sociologist Charles Tilly: war made Vladimir Putin, and Vladimir Putin made war. This book shows how.

Leningrad

Vladimir Vladimirovich Putin was born in Leningrad, today's Saint Petersburg, in 1952. The city young Vladimir knew bore the scars of its gruelling siege by the Nazis during the Second World War, a rundown wreck of broken buildings and hungry people. Thousands of orphaned, disowned and impoverished children roamed streets ruled by violent gangs. Putin shares his slight stature with many others of his generation, for they are the children of those who suffered most. Indeed, his may owe something to his mother's malnourishment.

Young Vladimir was raised in a shabby and spartan tenement block where the living accommodation was small and essential services communal. The Putins were by no means the worst off. Theirs was a middling lifestyle for 1950s’ Leningrad. Vladimir's father was a factory foreman. After a stint in the navy, he had served in an NKVD (secret police) unit operating behind enemy lines before transferring to the regular army where he was seriously injured. His paternal grandfather had reached an altogether more elevated status as Stalin's chef. He had served Lenin before that. Putin's mother worked in a factory too. Vladimir was the couple's third son, but his siblings were long dead before he was born. He was an unremarkable school student, but a resourceful and tough-minded player in a very rough city. He occasionally loitered with the street gangs but ultimately chose a different path for himself. Like young people on both sides of the Iron Curtain, Vladimir was captivated by spy movies. He wanted to serve the state, as his grandfather had. Judo club taught him the discipline and focus he needed. Legend has it that he presented himself to Leningrad's KGB headquarters and volunteered for service. The bemused officials turned him away and told him to apply again when he had obtained his law degree.

The 2020 war between Azerbaijan and Armenia over Nagorno- Karabakh is an outlier to the story told in this book. Vladimir Putin was neither the engineer nor instigator of war. Russia was not even a party. The 44-day war that erupted in late September was caused by a long-standing dispute between Azerbaijan and Armenia over who should govern Nagorno-Karabakh and the seven Azerbaijani districts occupied by Armenians since 1992. The war's wider, imperial, dimension was secondary to this primary, local, dimension. Yet that imperial dimension is an important part of our story.

Russia used the rivalry between Armenia and Azerbaijan to cement and attempt to extend its influence in the southern Caucuses. Although sentimentally predisposed towards Armenia, Russia attempted to maintain equidistance between the two rivals. This required a delicate balance since the geopolitical sands shifted significantly over time. Dependence on Russian security guarantees made Armenia a willing and loyal member of Russia's sphere of privileged interest, of the CIS, CSTO and Eurasian Union. Resource-rich Azerbaijan, meanwhile, wriggled free from Russia's orbit but not in a westward direction. Resource wealth and strategic location afforded Azerbaijan freedom to manoeuvre itself. Moscow needed Azerbaijan as much as Azerbaijan needed Moscow, forcing the Kremlin to deal with Baku on more equal terms. But Azerbaijan's increasingly authoritarian government had little inclination to embrace the West as anything more than a trade and investment partner. Autocracy thus placed normative distance between Azerbaijan and the West. To maintain influence amidst these changing conditions, Russian policy adapted to circumstance, sometimes at the cost of contradiction. It offered itself as peace mediator and seems genuinely to have pursued a settlement that could have resolved the conflict and established more stable conditions for the exercise of influence. Simultaneously, however, it sold weapons to both sides – an unusual stance for a mediator.

Amidst the delicate shifts and contradictions of policy, was one striking continuity. Among the Kremlin's enduring ambitions was the establishment of a Russian military presence inside Azerbaijan. Russia had just such a presence in Armenia. Fearful of both Azerbaijan and Turkey – memories of the 1915 genocide of more than a million Armenians during the death-throes of the Ottoman Empire understandably loomed large in the new Armenian state's political imagination – independent Armenia looked to Russia for security from the first.