making at the beginning of February, May, August and November. In the The CNB employs market instruments event of extraordinarily dramatic developments in the economy, however, a new fast-track forecast can also be put together in the interim. in its monetary policymaking

The Bank Board, however, holds a meeting regularly eight times a year; To implement its monetary policy decisions the CNB makes use of OF THE CZECH NATIONAL BANK besides already mentioned months also at the end of March, June, “indirect”, non-administrative market instruments. In other words, September and December. In these months, the Situation Report does he CNB makes monetary policy not by means of orders, prohibitions, not contain a new forecast but brings comparison of the latest key limits and suchlike, but by offering banks business transactions and macroeconomic figures with their forecast values, evaluates the situation commercial terms formulated in such a way that those banks in turn with respect to the possible future course of inflation, and updates the offer their partners transactions under terms the CNB views as desirable Principles, procedures, instruments The CNB is an independent at that particular moment. Through this basic mechanism, and via the uncertainties and risks attaching to the most recent forecast. Would you like to know a bit more about the Czech National Bank and open institution channels described earlier (i.e. via client interest rates, the Exchange than what you can find in the newspapers? The following fact sheet The meeting of the Bank Board usually begins at 9 a.m. with a discussion rate, etc.), the CNB’s monetary policy aims gradually spread through In the pursuit of its statutory objective, the CNB has a high degree will guide you around the world of the CNB. It’s a world that may seem of the Situation Report, which is always presented to the Bank Board more and more markets and transactions into the entire economy. of independence from political influence. Above all, it is independent by the Monetary and Statistics Department several days in advance. unremarkable, but the CNB’s work is in many respects crucial to the in making decisions on the settings of monetary policy instruments. The main CNB instrument is the two-week repo rate. Banks have the The board members are also provided with an opinion on the Situation Czech economy. Its independence is also reflected in the manner in which its senior option of depositing their excess liquidity at the CNB for a two-week Report under discussion, drawn up by one of their advisers, and a According to the Czech Constitution, the CNB’s primary objective officers are elected and dismissed (they are appointed and – under period on the basis of repurchase agreements (“repos”) at a rate not Monetary Policy recommendation. This document contains arguments is “to maintain price stability”. Without prejudice to this primary very strict conditions – dismissed by the Czech President). for the setting of higher/lower interest rates compared to the message exceeding the two-week repo rate. By changing the repo rate, the objective, the Czech National Bank is also tasked with supporting the The CNB’s independence protects it primarily from any political of the baseline scenario of the current forecast and a recommendation CNB influences short-term interest rates on the interbank market. “general economic policies of the Government leading to sustainable pressure to adopt measures to boost short-term economic growth, for by the Monetary and Statistics Department regarding the optimum This signal then spreads to interest rates throughout the economy, to economic growth”. This means that the CNB should set its main policy instance in the run-up to a general election. Such measures would in monetary policy action and the communication thereof. economic activity and ultimately to inflation. instrument, namely interest rates, at a level that will maintain inflation the longer term cause an undesirable rise in inflation, while growth in In some situations the CNB may use other instruments at its disposal. The discussion of the Situation Report at the Bank Board meeting opens at a low and stable level without needlessly slowing, or excessively economic activity would soon return to its original level, or even fall For instance, it may conduct FX interventions to influence the koruna with presentations by the Monetary and Statistics Department summing accelerating, the economic growth rate. below it (as a result of the increased inflation). up the main ideas and the message of the forecast, the Situation Report exchange rate and moderate excessive exchange rate volatility. The The CNB’s high degree of independence is counterbalanced by openness and the Monetary Policy Recommendation. The presentations end CNB has been using FX interventions since 2013 as part of its exchange with respect to disclosure of information. The CNB uses various channels with the formulation of the Monetary and Statistics Department’s own rate commitment with the aim of providing the required monetary High inflation damages the economy policy easing in a situation where monetary-policy interest rates have to inform the public about its monetary policy system, its inflation target, recommendation for the Bank Board in the area of the immediate interest The objective of achieving and maintaining low and stable inflation reached “technical zero”. its inflation forecasts and the attendant risks, and about its monetary rate settings and communication. Once the presentations are over, the is based on international experience that high and volatile inflation policy measures and its reasons for adopting them. To inform the public, members of the Bank Board are free to ask questions. In the final phase damages the economy. It causes this damage by creating uncertainty and the CNB not only issues quarterly Inflation Reports, which are submitted of the meeting, the Board goes into closed session to discuss the risks forcing money holders to focus on short-term projects. Economic growth, The ’s accession to the Chamber of Deputies (the lower house of the Czech Parliament) and uncertainties of the current forecast and the overall monetary policy meanwhile, is founded primarily on longer-term investment. High inflation to the euro area and published on the CNB’s website, but also releases minutes of the context and to subsequently vote on the monetary policy action. This also hampers inflation forecasting and thus introduces various distortions CNB Bank Board’s monetary policy meetings, holds news conferences, vote is not necessarily always unanimous and the final decision can differ Upon the accession of the Czech Republic to the and the into the economy: it changes the real value of debtors’ liabilities to their publishes articles and gives interviews in the press and other media, from the message of the current forecast and from the Monetary and Economic and Monetary Union, the CNB became part of the European creditors, creates distortions in the tax system, causes interest rates to be arranges presentations and speeches by Bank Board members, and so on. Statistics Department’s monetary policy recommendation. System of Central Banks. However, until the euro is introduced and the volatile (leading in turn to swings in the inflow and outflow of short-term CNB becomes part of the “”, the CNB will continue to conduct risk capital and hence to exchange rate fluctuations), and so on. Savers are The measures adopted are immediately disclosed in a press release and monetary policy autonomously. also often unaware that high inflation erodes the value of their savings. explained and expanded upon at an afternoon news conference, at The CNB steers inflation towards the which the ratio of the votes cast is also released. The press conference The Czech Republic has the status of “Member State with a derogation” The economic value of low inflation is also demonstrated by the fact official inflation target is made available to general public through audio and video recordings regarding the adoption of the euro, meaning that it will introduce the that maintaining inflation at low levels is currently the primary objective posted on the CNB website. A more detailed account of the discussion single currency later on. For EU member states, joining the euro area is of central banks in the majority of the advanced nations, including the Since January 1998, the CNB has conducted its monetary policy within leading up to the Bank Board’s decision is published eight days later in conditional on fulfilling the “Maastricht convergence criteria”. This is a European . an system. Putting it simply, the CNB has undertaken the minutes of the meeting. This account in the end presents votes of set of requirements defining areas in which the candidate countries must to try to maintain inflation under normal external economic conditions the Bank Board members by name on the change in interest rates. On converge towards the euro area economies. on course for an announced inflation target. This system has some occasion of release of the CNB´s new quarterly forecast (in February, significant advantages over other monetary policy regimes (such as money The CNB is convinced that the Czech Republic should not join the euro May, August and November), a forecast of the future development of targeting and exchange rate targeting). First of all, it focuses directly on area before economic conditions allow for doing so. In particular, it is the key economic variables (overall inflation, monetary-policy relevant necessary to continue with the public budget consolidation process and inflation, GDP, the CZK /EUR exchange rate and the path of interest rates with the structural reforms to increase labour market flexibility. At the consistent with the forecast) is also disclosed at the press conference same time, the euro area debt crisis and the methods being used to Czech National Bank held on the day the decision is made, and on the CNB website. The full resolve it are not creating favourable conditions for euro adoption in the Na Příkopě 28, 115 03 1, www.cnb.cz minutes of the Board meeting, the Situation Report and the Monetary Czech Republic. Policy Recommendation are published six years later. Date: April 2016 controlling inflation, a variable that directly affects the decision-making affect demand – i.e. how much households consume and firms invest Figure 2: Inflation in the Czech Republic Expected external economic developments are another important and behaviour of most of us in the areas of consumption, investment and and, conversely, how much both groups save. The exchange rate also (annual growth in consumer prices in %) assumption of the CNB forecast. To estimate the future evolution of the saving, even though we may not realise it. This central bank commitment usually reacts to changes in the CNB’s rates, especially if such changes external environment (prices of energy-producing materials, producer in the form of an inflation target is generally intelligible to the public and are sizeable and are perceived as long-term. The exchange rate in turn price indices abroad, the business cycles of the Czech Republic’s major 14 provides an anchor for inflation expectations. Figure 1 illustrates inflation strongly affects prices of imported goods and hence inflation. With a trading partners and the euro-dollar exchange rate), the CNB draws on 12 targets since the start of inflation targeting in the Czech Republic. longer lag it also affects exports and imports, aggregate demand and, the publication Consensus Forecasts, which brings together the Forecasts 10 again, inflation. of a whole range of foreign analytical teams, and market outlooks. 8 Figure 1: The CNB’s inflation targets The model also takes on board – in a simplified, model way – the 6 Alongside the estimate of the starting conditions, the initial meetings behaviour of the central bank itself which is consistent with its statutory 4 of the prediction team also deal with the so-called short-term forecast, objectives. The overall forecast therefore includes the projected path of 2 which is drawn up using single-equation and more sophisticated models 7 interest rates. In its materials for the public, the CNB calls this projection 0 and expert judgments and which describes economic developments in 6 -2 the “ trajectory consistent with the overall forecast”. The 1/98 1/00 1/02 1/04 1/06 1/08 1/10 1/12 1/14 1/16 the coming few quarters. The short-term forecast for the next quarter is 5 interest rate projection indicates the central-bank interest rate policy then entered into the core medium-term prediction model, which is made 4 that is consistent with the economic outlook and the inflation target. up of dozens of equations. The equations describe the key relationships target band for headline inflation 3 However, it should not be understood as a binding commitment by the Imagine that an external shock has caused inflation to move outside within the Czech economy and between the Czech economy and the rest point targets for headline inflation 2 targets for CNB as regards the current and future level of interest rates. It simply the target band over the coming quarters. The CNB could, of course, of the world. One of the core equations models the response of short-term net inflation 1 serves as a guide for real monetary policy decision-making. The arrival respond by dramatically changing its monetary policy instruments to interest rates to changes in inflation. This central bank response gradually 0 of new information since the forecast was drawn up and different views force inflation back on target. However, such a response could result returns inflation to the CNB’s target in the medium term. The forecast 1/00 1/02 1/04 1/06 1/08 1/10 1/12 1/14 1/16 1/18 1/20 of the board members of economic developments than those outlined in an undesirable destabilisation of the economy. Moreover, we need generated by the core prediction model is again subject to expert debate in the CNB forecast mean that the actual interest rate path may deviate to consider whether the manifestations of the shock in the first few in the prediction team and to other potential expert adjustments. This from the forecasted path. The same applies to the forecast for the quarters – known as its first-round effects – are in fact essential changes process of integration of the expert and model views of future economic exchange rate of the koruna to the euro. The CNB is the only central in relative prices which ought not to be suppressed, i.e. the economic and developments is the most demanding and time-consuming part of the Monetary policy needs bank in the world to publish a forecast for the nominal exchange rate price system is adjusting to the new situation by means of such changes, forecasting process. At the end of this process we obtain the final version to be forward-looking vis-ŕ-vis a specific currency. meaning that strictly speaking they are not changes in inflation at all. of the baseline scenario of the CNB’s macroeconomic forecast. If such first-round effects are very strong, the official inflation rate can The forecast may therefore be viewed as the outcome of model and Owing to the lag that arises between the implementation of a monetary depart from the inflation target band. For these reasons the CNB – like expert procedures, detailed considerations of short-term shocks, and policy measure and its greatest impact on inflation, the CNB’s monetary Why is the inflation target other inflation-targeting central banks – repeatedly tells the public in comprehensive considerations of medium-term and long-term trends. policy decision-making is guided not by the present situation but by the sometimes not hit? its publications that there may be situations where it is economically Along with the preparation of the most likely economic scenarios, forecast for the future – rather like someone deciding what to put on right to accept temporary non-fulfilment of the inflation target. The however, the main uncertainties and risks associated with the baseline when leaving home in the morning not according to the weather outside Despite carefully considered monetary policy decisions, inflation can CNB’s monetary policy is focused on suppressing the second-round scenario of the forecast (e.g. regarding external developments, the but according to the forecast for the whole day. By the CNB’s estimates, sometimes diverge from the target. This happens mainly when such effects of the shock, which can emerge later as unwanted and evolution of public budgets, uncertainties regarding the future interest rate changes have their greatest impact on inflation some 12 to decisions are based on predictions that fail to materialise. Economic genuinely inflationary ”echoes” of the first-round effects. development of key variables, etc.) are also discussed. On the basis of 18 months further down the line. Consequently, the CNB concentrates forecasting is a very difficult business, and all macroeconomic this discussion, specific alternative scenarios for the macroeconomic on this horizon in its monetary policy deliberations, although of course forecasts – not just those drawn up by the CNB – can turn out to be forecast can then be formulated at a second meeting with the Bank it also takes into account developments before and after this period. wide of the mark to a greater or lesser extent. The inflation forecast takes several Board – a “meeting on alternative scenarios”. The baseline scenario The most frequent – although by no means only – cause of failures The forecasts for inflation and the economy as a whole are based on weeks to draw up and any alternative scenarios are then described in the Inflation Report, of macroeconomic forecasts is a sharp change in the value of some past and present developments, on assumptions regarding several key which is published eight days after the forecast has been discussed at the external variable of relevance to Czech inflation. Such variables, which The key source material for the CNB Bank Board’s decisions is the CNB’s variables. The forecast is created using a sophisticated model of the relevant monetary policy meeting of the Bank Board. Roughly the same include the exchange rate and world prices of raw materials and food, macroeconomic forecast. This forecast is drawn up by the Monetary workings of the Czech economy. However, it is also significantly affected description of the forecast – supplemented with technical passages that can be predicted only with a high degree of uncertainty. But they have and Statistics Department in interaction with the board members. It by the professional discussions and expert opinions of CNB economists. are of little interest to external readers – is then given in the Situation regular and discernible impacts on Czech inflation, as evidenced by the represents the CNB experts’ views of the most likely future evolution of the Report, which is an internal document intended for the Bank Board’s The prediction model is based on the CNB’s knowledge of how strongly nation’s rather troubled inflation history (see Figure 2). In past years, economy, including the behaviour of the central bank itself. The forecast decision-making and which is published six years later. – and with what kind of lag – developments in the external environment difficult-to-predict changes to administered prices, fees and indirect is based on a consistent medium-term framework taking the form of a (such as changes in inflation or economic growth in other countries and taxes have also played a major role in determining inflation. model approach which is supplemented with an expert opinion primarily world prices of raw materials), price-related administrative decisions affecting the short-term forecast horizon. The most relevant for monetary The Bank Board makes decisions on made by Czech state and local authorities, and, in particular, changes to policy decision-making is the inflation forecast at the so-called monetary the basis of Situation Reports the CNB’s interest rates, pass through into various areas of the economy policy horizon (about 12-18 months ahead), which affects the current and ultimately into inflation. The two most important channels whereby interest rate settings. The forecast is prepared by a large team of specialists The situation in the Czech economy does not usually change fast enough changes to the CNB’s rates affect the economy run via client interest working in the CNB’s prediction team. The process of compiling the to warrant this very time-consuming forecasting process each and every rates and via the Exchange rate. Client interest rates, i.e. the lending forecast takes about one month, taking the form of a series of meetings of month. The forecast is thus prepared by the Monetary and Statistics and deposit rates that commercial banks offer to households and firms, the prediction team. The initial meetings deal with the starting conditions Department once a quarter, so that important statistical data published move in step with changes in the CNB’s rates. Client interest rates in turn of the forecast, in particular the position of the domestic economy in the quarterly can also be incorporated. The forecast is submitted to the business cycle. The settings of the starting conditions largely determine the supreme governing body of the CNB, the seven-member Bank Board, message of the forecast. For this reason, the Bank Board is also involved in in an internal document entitled the Situation Report on Economic and this discussion by means of a “meeting on the starting conditions”. Monetary Developments as a key material for its monetary policy decision