Czech Republic: 20 Years of Inflation Targeting and the Way Forward

Marek Mora Deputy Governor of the Czech National Bank

Central Bank of Malta Valletta, 12 November 2019 Outline

I. Economic situation in the Czech Republic II. 20 years of inflation targeting III.The way forward and the question of euro adoption

2 I. Economic situation in the Czech Republic

3 Economic prosperity

GDP per capita in PPP (2018; EU-28=100) 200

180

160

140

120

100

0 BG HR RO EL HU LV PL PT SK EE LT CY SI CZ ES IT MT FR UK FI BE SE DE DK AT NL IE Note: Luxembourg not shown (254). Source: Eurostat. • In 1993–2018, cumulative real GDP growth was 94%, or 2.7% p.a. • In 2018, GDP per capita at purchasing power parity reached 90% of the EU-28 average • Second biggest car producer per capita in world (behind Slovakia) 4 Fiscal situation

Fiscal positions of EU-28 countries LU 2 MT BG DE EL CZ SE NL 1 SI LT DK HR 0 SK IE AT PL BE PT -1 EE LV FI UK -2 IT RO HU ES FR -3

Govt budget balance (% GDP) balance(% budgetGovt -4 CY -5 0 30 60 90 120 150 180 Govt debt (% GDP)

Source: Eurostat (September 2019). • Public debt level was 32.7% of GDP in 2018

5 Labour market

Unemployment rate (%, Sept. 2019) Employment rate (%) 18 80 16 2019Q2 2005Q2 70 14 60 12 50 10 40 8 30 6

4 20

2 10

0 0

HU MT

Note: Seasonally adjusted data. August 2019 for EE, HU. July 2019 for EL, UK. EU-28 Source: Eurostat Source: Eurostat

• Unemployment rate is the lowest in EU (2.1% in September 2019) • Employment rate has increased since 2005 • Among EU countries with the highest levels of social cohesion 6 II. 20 years of inflation targeting

7 20 years of inflation targeting (1)

Source: Hammond (2012)

• Czech Republic was the first emerging economy to introduce inflation targeting in 1998 with the aim to achieve low inflation

8 20 years of inflation targeting (2)

• First decade (1998-2008): disinflation and inflation stabilisation

• Second decade (since 2009): effects of the financial crisis – unconventional monetary policy and back to normal

9 First decade (1998-2008): disinflation and inflation stabilisation

10 1998-2008 Since 2009

8 net inflation headline inflation 6 targets headline inflation net inflation targets 4

-2 1/98 1/00 1/02 1/04 1/06 1/08 1/10 1/12 1/14 1/16 1/18

• Inflation rapidly reduced to values observed in developed countries • However, there were significant temporary deviations from the target due to several (mainly external) shocks

10 Second decade (since 2009)

10 1998-2008 Since 2009

8 net inflation headline inflation 6 targets headline inflation net inflation targets 4

-2 1/98 1/00 1/02 1/04 1/06 1/08 1/10 1/12 1/14 1/16 1/18

• Lowering the inflation target as of 2010 by 1 percentage point (to 2% with a tolerance band of +/- 1 p.p.)

11 Monetary policy reaction to the global financial crisis

6 30

5 CZK/EUR (rhs) 28

4 Exchange rate commitment (27 CZK/EUR) 26

3 % 24 2 CZK/EUR Lombard rate 2W repo rate 22 1 Discount rate

0 20 1/08 1/09 1/10 1/11 1/12 1/13 1/14 1/15 1/16 1/17 1/18 1/19

• Lowering of interest rates starting in summer 2008

12 Monetary policy reaction to the euro area debt crisis (1)

6 30

5 CZK/EUR (rhs) 28

4 Exchange rate commitment (27 CZK/EUR) 26

3 % 24 2 CZK/EUR Lombard rate 2W repo rate 22 1 Discount rate

0 20 1/08 1/09 1/10 1/11 1/12 1/13 1/14 1/15 1/16 1/17 1/18 1/19

• Due to renewed lengthy recession, rates started approaching zero lower bound in 2012

13 Monetary policy reaction to the euro area debt crisis (2)

10 1998-2008 Since 2009

8 net inflation headline inflation 6 targets headline inflation net inflation targets 4

-2 1/98 1/00 1/02 1/04 1/06 1/08 1/10 1/12 1/14 1/16 1/18

14 Exchange rate floor as a monetary policy instrument (1)

6 30

5 CZK/EUR (rhs) 28

4 Exchange rate commitment (27 CZK/EUR) 26

3 %

24 CZK/EUR 2 Lombard rate 2W repo rate 22 1 Discount rate

0 20 1/08 1/09 1/10 1/11 1/12 1/13 1/14 1/15 1/16 1/17 1/18 1/19

• Introduction of exchange rate floor at 27 CZK/EUR in November 2013

15 Exchange rate floor as a monetary policy instrument (2)

10 1998-2008 Since 2009

8 net inflation headline inflation 6 targets headline inflation net inflation targets 4

-2 1/98 1/00 1/02 1/04 1/06 1/08 1/10 1/12 1/14 1/16 1/18

16 Normalisation of monetary policy since April 2017

6 30

5 CZK/EUR (rhs) 28

4 Exchange rate commitment (27 CZK/EUR) 26

3 % 24 2 CZK/EUR Lombard rate 2W repo rate 22 1 Discount rate

0 20 1/08 1/09 1/10 1/11 1/12 1/13 1/14 1/15 1/16 1/17 1/18 1/19 • FX floor was abandoned on 6 April 2017, as conditions for sustainable fulfilment of 2% inflation target had been met • Exit was smooth and was followed by eight interest rate hikes between 8/2017 and 5/2019. Czech koruna appreciated gradually and moderately 17 Summary

• The successful conduct of monetary policy under inflation targeting brought inflation down from high values to the level usual in advanced countries

• Subsequently, this regime was able to cope with the threat of harmful deflation during a lengthy domestic recession thanks to the use of the exchange rate as an additional monetary policy instrument

• Czech Republic has successfully moved towards normalization of monetary policy

18 III. The way forward and the question of euro adoption

19 Pros and cons of the euro adoption

Pros (benefits) • Zero exchange rate risk with the main trading partners • Lower transaction costs (no need for exchange) • Higher price transparency and more competition • Deeper economic integration (?)

Cons (costs) • Loss of an important macroeconomic adjustment variable • Higher degree of economic sovereignty (?)

The higher the cyclical and structural alignment with the euro area and the more flexible the economy, the more the benefits should be higher then the costs 20 Czech Republic’s assessment of euro adoption preparedness

• High degree of openness of the Czech economy

• Persisting strong trade and ownership links

• Gradually rising use of the euro by non-financial corporations

• Signs of increasing labour market flexibility

• Stable banking sector resilient to economic shocks

------

• Still unfinished process of real economic convergence

• Persisting lower structural similarity of economies

• Misalignment of financial cycles

• Czech public finance sustainability yet to be resolved

21 Concluding remarks on euro adoption

• Regardless the costs and benefits, the Czech Republic is obliged to adopt the euro since the EU entry • Czech economy would manage to join the euro area as it converges to the euro area core as well as to the EU average • Euro area faces many problems: some (big) economies do not converge; still incomplete and with many question marks • Our obligation to adopt the euro is debatable because of new elements/duties linked to this obligation (e.g. additional costs related to joining the ESM) • Euro adoption is not on the agenda in the near future

22 Thank you for your attention

www.cnb.cz

Marek Mora Deputy Governor [email protected]

23 Additional slides

24 Activities of the Czech National Bank

• Monetary policy to maintain price stability (flexible inflation targeting) • Issuing banknotes and coins • Payment and currency in circulation management • Financial stability • Financial market supervision • Resolution • Consumer protection

25 Setting of countercyclical capital buffer rate

Applicable and announced CCyB rate in the Czech Republic Countries with non-zero CCyB rate (% of total risk exposure) (% of total risk exposure) 2.50 3.0

2.25 2.5 2.00 2.0 1.75

1.5 1.50

1.25 1.0

1.00 0.5

0.75

0.0

DE BG 0.50 NO 10/18 01/19 04/19 07/19 10/19 01/20 04/20 07/20 Current CCyB rate Applicable CCyB rate Announced CCyB rate

Announced CCyB rate Source: ESRB

Source: CNB • Rise in CCyB rate to 2.0 % with effect from July 2020 is based on assessment of position of economy in financial cycle and of banking sector vulnerability indicators • Fifteen European countries have set non-zero CCyB rates; in eleven non-zero rate already effective. Eleven have announced rate increase (including CZ) 26 Regulation of mortgage loans

Estimated overvaluation of apartment prices Loans for house purchase in % of total private non-financial loans (%) 55 50 31.3.2015 30.6.2015 40 50 30.9.2015 31.12.2015 30 31.3.2016 45 30.6.2016 20 30.9.2016 31.12.2016 10 40 31.3.2017

0 30.6.2017 35 30.9.2017 -10 31.12.2017 31.3.2018 30 -20 30.6.2018 9/10 9/11 9/12 9/13 9/14 9/15 9/16 9/17 9/18 9/19 06/09 06/11 06/13 06/15 06/17 06/19 30.9.2018 Prudential approach Valuation approach Source: CNB 31.12.2018 Source: CNB Note: The methodology of the indicators is described in detail in Plašil, M., Andrle, M. (2019): Assessing House Price Sustainability , Thematic Article on Financial Stability 1/2019, CNB. • Upper LTV limit of 80%; max. 15% of loans for LTV of 80%–90%; no loans for LTV above 90% • Upper DTI limit of 9 times applicant’s net annual income and DSTI limit of 45% of applicant’s net regular income • Cap on maturity of 30 years, requirement of regular amortization 27 Public support to the euro

Source: Eurobarometer, Spring 2019

28 CZK/EUR exchange rate and FX interventions

29 FX interventions (right axis) 19258 20000 CZK/EUR Exchange rate commitment 18000 28 16000 14481 27 14000 EX commitment 12000 26 27CZK/EUR 7 Nov 2013 - 6 Apr 2017

10000 EUR

8139 mil CZK/EUR 25 7499 8000

24 6000 3961 3735 3685 4000

23 23222154 2000 1033 1059 653

22 0

1/13

1/14

1/15

1/16

1/17

1/18 1/19 Source: CNB • FX interventions amounted to 75.9 bil. EUR during the exchange rate commitment period from 7 Nov. 2013 to 6 April 2017 (of which 42.5 bil. EUR in 2017) 29 Central bank total assets to nominal GDP in national currency (in %) 140

Federal Reserve System 120 European Central Bank

Bank of England 100 Bank of Japan

Swiss National Bank 80 Czech National Bank

0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019

Source: Bloomberg, Central Bank websites 30 Transparency of monetary policy

8 Sweden Czech Republic 6 Hungary 4 Iceland United Kingdom 2 United States 0 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Note: Top 6 countries ranked by the monetary policy transparency index. Source: Dincer, Eichengreen and Geraats (2019). • According to the monetary policy transparency index, CNB ranked second among the most transparent central banks in 2015 • As of January 2020, CNB will further increase transparency by introducing attributed minutes 31 CZK/EUR exchange rate

28 27 26 25 24 23 22 21 IV/17I/18 II III IV I/19 II III IV I/20 II III IV I/21 II

90% 70% 50% 30% confidence interval

Note: The confidence intervals of the CZK/EUR exchange rate forecast reflect the predictive power of past forecasts (with the exception of the exchange rate commitment period). They are symmetric and linearly widening. Source: CNB Inflation Report, November 2019

32 Interest rates (in %) Client interest rates (in %)

3.0 4.0

2.5 3.5 2.0 3.0 1.5 2.5 1.0 0.5 2.0

0.0 1.5 -0.5 1.0 -1.0 1/15 1/16 1/17 1/18 1/19 I/15 I/16 I/17 I/18 I/19 Czech Republic: loans to non-financial corporations 3M PRIBOR 3M EURIBOR Euro area: loans to non-financial corporations