The Czech Economy and Monetary Policy: Deflationary Risks and the Exchange Rate as a Monetary Policy Instrument Luboš Komárek

Transcription

1 The Czech Economy and Monetary Policy: Deflationary Risks and the Exchange Rate as a Monetary Policy Instrument Luboš Komárek 75th East Jour Fixe - 1 Years of EU Enlargement Vienna, 25th April 214

2 I. Did the flexible exchange rate regime help to keep the economy competitive in the boom years? 2

3 I. Did the flexible exchange rate regime help to keep the economy competitive in the boom years? 1. A small open economy with a flexible exchange rate regime like the Czech Republic must always bear in mind that: the exchange rate could behave either as a shock absorber or as a shocks generator (source of shocks). a flexible exchange rate in a (post)-transition economy can also serve as a channel of nominal convergence towards the advance economies. 2. The Czech Republic introduced the flexible exchange rate in May 1997 as a reaction on exchange rate turbulences. Since then we observed an appreciation trend until the financial crisis of 28. The appreciation trend was in line with the nominal convergence of the Czech economy when domestic inflation remained at low levels and well anchored. The exchange rate thus served as a tool against overheating of the booming economy. 3. Overall, the flexible exchange rate regime had stabilizing effect on the economy and minor fluctuations were absorbed in exporters profit margins. However, in 22 and in 27, we saw abrupt appreciation of the Czech Koruna. Because these swings could endanger the competitiveness of the economy, the CNB reacted. 3

4 I. Did the flexible exchange rate regime help to keep the economy competitive in the boom years? In 22, appreciation was caused by huge capital inflow (seen as an external factor, i.e. shock to the economy). The CNB lowered the interest rates and additional measures were also implemented (e.g. sterilization of privatization FDI). This helped to ease monetary conditions. In 27, possible carry trade operations were probably behind the Koruna depreciation in the first half of the year. In these times the Czech Republic had lower interest rates compared to the euro area. Beginning of the global financial crisis led to selling out of risk assets and subsequently to repayments of loans in Koruna which served as a financing currency. This caused an abrupt appreciation of the Koruna. When the Czech economy was hit by the global financial crises in 29, the Koruna weakened and helped thus to ease monetary conditions while the external demand slumped. Since the global financial crises the Koruna has been moreover flat until the CNB used the exchange rate as the tool of monetary policy from 7th November 213. Later, the experience of the Czech Republic shows the advantage of having additional monetary instrument in ZLB constraint situation, which the CNB reached in November

5 CNB interventions / ER as the tool of monetary policy mil. EUR 7499 mil. EUR 22 1/98 1/99 1/ 1/1 1/2 1/3 1/4 1/5 1/6 1/7 1/8 1/9 1/1 1/11 1/12 1/13 1/14 intervention buy-up from Privatisation Account to forex reserves sale of forex reserves yields CZK/EUR mil. EUR Sales of FX reserves yields were halted in November 212 in order to avoid the possible conflict of monetary policy implementation in case of commencement of FX intervention to weaken the CZK/EUR exchange rate. 7th November 213: the CNB decided to switch to an alternative scenario and start using the exchange rate as an instrument for further monetary easing CNB s commitment to hold the exchange rate close to 27 CZK/EUR level (at least to beginning 215) 5

6 Comparison of model scenarios (Board meeting on 7th November 213) 4 Headline inflation (y/y in %) 4 MP-relevant inflation (y/y in %) I/12 III I/13 III I/14 III I/15 III -1 I/12 III I/13 III I/14 III I/15 III 1,4 1,2 1,,8,6,4 3M PRIBOR (in %) GDP (y/y in %) Baseline scenario Passive MP Passive MP +ER shock Alternative scenario,2, -,2 -,4 -,6 I/12 III I/13 III I/14 III I/15 III I/12 III I/13 III I/14 III I/15 III The relevant policy comparison was between the alternative scenario with exchange rate instrument and the passive MP scenario(s) here the difference clearly favours the former in all major variables (plus recall the uncertainty as regards the return to the target with passive MP). 6

7 2W repo rate path Comparison of all scenarios (Board meeting on 7th November 213) The alternative scenario assumes exit in 1.Q 215, but it might come later in reality (the Board may take a different view, premature exit must be avoided, the ER pass through might prove weaker, economic situation may change etc.). 7

8 II. Currently, the Czech Republic experiences very low inflation. How do you deal with this situation? 8

9 II. Currently, the Czech Republic experiences very low inflation. How do you deal with this situation? Q1 2Q1 22Q1 24Q1 26Q1 28Q1 21Q1 212Q1 214Q1 Total CPI MP inflation Net inflation (excluding tax changes) Regulated prices (excluding tax changes) Regulated prices (including tax changes) Historically, inflation in 213 was at very low levels. In the last fifteen years, a similar reduction in inflation occurred at the turn of 22/ : (i) clear decline in wage growth in the business sector, (ii) weak effective foreign demand, (iii) effect of domestic restrictive fiscal policy and (iv) stronger exchange rate. The only Inflation component with a growth outlook was food prices, mainly due to the trend growth of agricultural commodity prices on world markets in recent years, but with a distinct slowdown in prices expected in late 213 and 214 also. 9

10 II. Currently, the Czech Republic experiences very low inflation. How do you deal with this situation? The CNB restricting monetary policy given by the lower limit of zero policy rates (base rate 2W repo was set since late 212 on the technical zero). Risk of deflation at least in the first half of 214. The deflationary risk was also amplified the potential appreciation of the koruna due to higher domestic real interest rates coupled with the expected recovery of the economy 's main trading partners in a situation of relaxed monetary policy in the world and the gradual unwinding of domestic government measures in the fiscal area. The published data thus confirm the CNB's view that the November decision to start using the exchange rate as an additional instrument of monetary policy contributed significantly to ward off the threat of deflation. Outcomes of the weakening of the exchange rate (up to now): (i) (ii) (iii) higher import prices higher consumer prices higher net nominal exports higher GDP growth higher inflation expectation higher domestic consumption 1

11 Inflation expectations Outlook for 12 and 36 months 11

12 Headline inflation forecast (Inflation Report I/214) 6 5 Monetary policy horizon Inflation target 1-1 I/12 II III IV I/13 II III IV I/14 II III IV I/15 II III 9% 7% 5% 3% confidence interval 12

13 GDP growt forecast (Inflation Report I/214) I/12 II III IV I/13 II III IV I/14 II III IV I/15 II III 9% 7% 5% 3% confidence interval 13

14 Conclusion Before November 213 the Czech National Bank (CNB) used its standard instruments to ease the monetary conditions. The key monetary policy rate was lowered gradually and reached the technical zero bound in autumn 212. In order to avoid long-term undershooting of the inflation target and to speed up the return to the situation in which it will be able to use its standard instrument, i.e. interest rates, the CNB has started to use the exchange rate as an additional monetary policy instrument. The CNB is resolved to intervene on the FX market in such volumes and for such duration as needed to reach the desired exchange rate level with the aim of hitting its inflation target in the future. 14

15 Reaction of international institutions IMF and OECD statements about interventions Fund advice, at the last Article IV Consultation, was that if a persistent and large undershooting of the inflation target is in prospect, FX interventions should be employed. The current situation justifies the CNB s action from that perspective. - Mr. Masanori Yoshida, Mission Chief for Czech Republic, International Monetary Fund. If a persistent and large undershooting of the inflation target is in prospect, additional tools should be employed. Foreign exchange (FX) interventions would be an effective and appropriate tool to address deflationary risks in the context of inflation targeting framework... Mr. Johann Prader, the Executive Director representing Czech Republic in the Executive Board of the International Monetary Fund. Low demandside pressures and decelerating food prices are containing inflation pressures in the near term. With interest rates technically at zero and excess liquidity in the banking sector, the National Bank has started foreign exchange interventions to prevent a long-term undershooting of the inflation target. Foreign exchange interventions should continue until inflation rises into the boundaries of the inflation target range and conventional monetary policy tools become effective again, - Organisation for Economic Co-operation and Development.

16 Thank you for your attention! Luboš Komárek Director External Economic Relations Division Monetary and Statistics Department

17 The exchange rate development ( ) depreciation band +/-7,5% Feb May band +/-,5% Sep Feb the level of ER against the former currency basket (65% DEM, 35% USD) appreciation targeting of M2 and until May 26, 1997 ER as well inflation targeting -4 1/91 1/92 1/93 1/94 1/95 1/96 1/97 1/98 1/99 1/ 1/1 1/2 1/3 1/4 1/5 1/6 1/7 1/8 1/9 1/1 1/11 1/12 1/13 1/14 17

18 Real GDP growth (s.a., y/y in %) II. Currently, the Czech Republic experiences very low inflation. How do you deal with this situation? Czech Republic eurozone The Czech economic cycle has become synchronized with the euro area, with a double-dip pattern 18

19 CZK/EUR Nominal exchange rate development 28, 27,5 27, 26,5 26, 25,5 Communication of the CNB s Bank Board regarding the possibility of monetary easing through the weakening of the exchange rate CNB s commitment to hold the exchange rate close to 27 CZK/EUR level FX intervention (7 November 213) 25, 24,5 but the effect of verbal intervention gradually began to fade 24, 1/12 2/12 3/12 4/12 5/12 6/12 7/12 8/12 9/12 1/12 11/12 12/12 1/13 2/13 3/13 4/13 5/13 6/13 7/13 8/13 9/13 1/13 11/13 12/13 1/14 2/14 After the notification of the CNB s Bank Board at a press conference on 7th November 213 to initiate FX interventions and to use the exchange rate for the further easing of monetary policy, the exchange rate immediately depreciated to the desired level of 27 CZK/EUR 19

20 Structure of the Czech GDP growth Annual GDP growth structure (annual percentage changes; contributions in percentage points; seasonally adjusted) I/7 I/8 I/9 I/1 I/11 I/12 I/13 Household consumption Gross fixed capital formation Change in inventories Net exports Government consumption GDP growth Post-Lehman decline mainly due to falling inventories and fixed investments, recently private consumption as well The main driver of Czech GDP growth has been net exports 2

21 Slovakia Hungary Netherlands Lithuania Malaysia Czech Republic Bulgaria Serbia Germany Poland Croatia Romania Zambia Philippines Canada South Africa New Zealand Greece Uganda Turkey India Russian Federation Indonesia Foreign trade of goods and services in 212 (% of GDP) 21

22 Economic openness of the Czech Republic Exports of G&S (% of GDP) Imports of G&S (% of GDP) High and increasing openness to foreign trade The level of exports is very closely linked to imports 22

23 Foreign trade (y/y in %, s.a.) /I III 7/I III 8/I III 9/I III 1/I III 11/I III 12/I III 13/I III Real exports Real imports Sharp drop in foreign demand in post-lehman period After the financial crisis export growth has slowed down gradually, exports mainly directed to the core euro area 23

24 Output gap (in % of potential output) I/6 I/7 I/8 I/9 I/1 I/11 I/12 I/13 HP filter Kalman filter Production function Some overheating before the crisis Negative output gap since early-29 (Kalman filter), currently remains significantly negative 24

25 Inflation targets target % +/-,5p.b. (set in Dec 97) target 2 4,5 +/- 1p.b. (set in Dec 97) target ,5 +/-,5p.b. (set in Nov 98) start of the target band 3-5 % target band (set in April 1) end of the target band 2-4 % point target of 3 % announced in March target 21 3% +/- 1p.b. (set in Apr ) point target of 2 % announced in March 27 12/97 12/98 12/99 12/ 12/1 12/2 12/3 12/4 12/5 12/6 12/7 12/8 12/9 12/1 12/11 Currently a 2% target (since January 21) 25

26 Achievement of targets target % +/-,5p.p. target1999 4,5 +/- target 2 4,5 +/- 1p.p. target 21 3% +/- 1p.p. start of target band 3-5 % target band ( announced 4/21) end of target band 2-4 % point target 3% (announced 3/24) target 25 2%+/- 1 p.p. announced 4/1999) point target 2% (announced 3/27) headline inflation net inflation -1 1/98 1/99 1/ 1/1 1/2 1/3 1/4 1/5 1/6 1/7 1/8 1/9 1/1 1/11 1/12 1/13 1/14 Since (CZK depreciation, deregulations) gradual disinflation process, low inflation since 1999 Inflation has been volatile due to commodity price shocks and changes in indirect taxes and administered prices 26

27 CNB key interest rates (percentages) W repo Monetary policy during crisis 1W repo rate and 1W PRIBOR 75%, the Lombard rate 5% in May W PRIBOR discount rate the Lombard rate 1/93 1/94 1/95 1/96 1/97 1/98 1/99 1/ 1/1 1/2 1/3 1/4 1/5 1/6 1/7 1/8 1/9 1/1 1/11 1/ Process of disinflation led to their fall to historically low levels 27

28 5 CNB key interest rates (percentages) Monetary policy during crisis /7 1/8 1/9 1/1 1/11 1/12 1/13 1/14 Lombard rate 2W repo rate Discount rate Monetary policy easing in 28-21, 2W Repo rate cut from 3.75% to.75%, three further rate cuts in 212 Main policy rate currently at the technical zero lower bound level.5% 28