Monetary Policy of the Czech National Bank and the European Central Bank

The Faculty of Law of Masaryk University Law and Legal Science Department of Financial Law and Economics

Diploma Thesis

Lucie Ostrá

Brno 2018

Declaration I hereby declare, that this diploma thesis titled Monetary Policy of the Czech National Bank and the European Central Bank has been composed solely by myself. All bibli- ographical references and sources of information used for writing this thesis have been properly cited in footnotes and are contained in the list of sources.

Brno, 30 October 2018 ...... Lucie Ostrá

Acknowledgement The author wishes to thank JUDr. Johan Schweigl, Ph.D. for consultations, valuable pieces of advice, and professional guidance while writing this diploma thesis.

Abstract

The thesis concerns monetary policy of the Czech National Bank and the European Cen- tral Bank with the aim to examine and compare the unconventional monetary policy instruments employed by the CNB and the ECB after the 2008 economic and financial crisis. After monetary policy in general and its regulation by law is described, the monetary policy of each of the central banks is described alone, and subsequently the findings are compared together based on 6 criteria concerning both economic and legal aspects to provide for clear findings on similarities and differences between (un)conventional monetary policy of the two central banks.

Keywords Monetary policy, Czech National Bank, European Central Bank, Economic and Monetary Union, European System of Central Banks, unconventional monetary policy instruments

Abstrakt Diplomová práce se zabývá měnovou politikou České národní banky a Evropské centrální banky s cílem zkoumat a porovnat nekonvenční měnověpolitické nástroje zavedené ČNB a ECB po hospodářské a finanční krizi z roku 2008. Po pojednání o měnové politice obecně a její úpravě v právu, je zkoumána měnová politika každé z daných centrálních bank zvlášť a následně jsou zjištění porovnána na základě 6 stanovených kritérií týkajících se jak ekonomických, tak právních aspektů, za účelem dosažení jasných zjištění ohledně podobností a rozdílů mezi (ne)konvenční měnovou politikou daných dvou centrálních bank.

Klíčová slova Měnová politika, Česká národní banka, Evropská centrální banka, Evropský systém cen- trálních bank, Evropská měnová unie, nekonvenční nástroje měnové politiky

Table of Contents

Introduction 11

1 General remarks on monetary policy 14 1.1 Notion of monetary policy and basic terminology ...... 14 1.2 Monetary policy and legal regulation ...... 17 1.3 Independence of central banks and accountability for monetary policy ...... 19

2 Monetary policy of the Czech National Bank 23 2.1 Objective of monetary policy ...... 23 2.2 Instruments ...... 24 2.3 Independence and accountability for monetary policy ...... 27

3 Foreign exchange interventions of the Czech National Bank 30 3.1 Background ...... 30 3.2 Reasons for employing the unconventional monetary policy instrument ...... 31 3.3 Conduct of the foreign exchange interventions ...... 32 3.4 Legal assesment ...... 34

4 The European System of Central Banks 36 4.1 Economic and Monetary Union ...... 36 4.2 Structure and tasks of the ESCB ...... 39 4.3 Position of the Czech National Bank within the ESCB ...... 42

5 Monetary policy of the European Central Bank 45 5.1 Objective of monetary policy ...... 46 5.2 Instruments ...... 46 5.3 Independence and accountability for monetary policy ...... 49

6 Non-standard monetary policy measures of the ECB 51 6.1 Background ...... 51 6.2 Applied unconventional monetary policy instruments ...... 51 6.3 Legal assessment ...... 56 10

7 Author’s findings: comparison of unconventional monetary policy of the CNB and the ECB 58 7.1 Aim pursued ...... 58 7.2 Chosen instruments ...... 60 7.3 Outcome of the unconventional monetary policy ...... 62 7.4 Power to define and conduct (un)conventional monetary policy ...... 64 7.5 Character of monetary policy decisions ...... 66 7.6 Judicial review ...... 67

Conclusion 73

Sources 75 Monographs and articles ...... 75 Legal documents ...... 76 Court judgements ...... 78 Online sources ...... 79

Introduction

Importance of conducting monetary policy has become crucial over time. Nowadays, when the money is not backed up by e.g. gold in its entirety, there is a need to secure functioning monetary system and monetary issues cannot be left solely to the social and economic market forces.1The euro, similarly as other currencies, is regulated by a central bank, the European Central Bank (‘ECB’), which has the competence of monetary policy for the European Union(‘EU’). The Czech Republic is, however, one of the member states which has not yet adopted the euro although it has, by accessing to the European Union in 2004, taken upon itself the obligation to adopt it when conditions – the convergence criteria – set out in the Treaty on the Functioning of the European Union2(‘TFEU’) are fulfilled. Therefore, currently and until the moment the Czech Republic adopts the euro, the monetary policy in the Czech Republic is defined and conducted by the Czech Na- tional Bank (‘CNB’) whereas the ECB together with the national central banks of member states of the Euro area conduct the single monetary policy of the Union.

The financial and economic crisis from 2008 caused that central banks took a re- course to use of unconventional monetary policy instruments since conventional monetary policy instruments employed until that time showed to be insufficient to achieve objectives of their monetary policies3 in times of crisis and after it. These became subject of discussion where their effectiveness, compliance with the mandate/powers of the relevant central bank and independence of the relevant central bank is being disputed.

1 HERRMANN C., CORINNA D. International and European Monetary Law: An Introduction. Cham: Springer, 2017. SpringerBriefs in Law. p. 9. 2 Article 140 of the Consolidated version of the Treaty on the Functioning of the European Union, O.J. C 202/47, 7.6.2016. 3 SCHWEIGL J., BLAŽEK J. Monetary policy in the twenty-first century. In: Radvan M. et al. (eds.) Fi- nancial law towards challanges of the XXI century: Conference proceedings. Brno: Masaryk Univer- sity, 2017. p. 89. 12

The aim of this thesis is, while analysing the monetary policy of the CNB and the ECB, to examine the unconventional instruments of monetary policy used by the CNB and the ECB in greater detail and compare them, focusing mainly on the legal aspects.

Reasons for examining and comparing unconventional monetary policy instruments of the CNB and the ECB are following: 1. Comparing the practice of the two central banks contributes to the study of unconventional monetary policy instruments, 2. there is already a level of cooperation between these central banks in some areas stemming from the fact that the CNB is part of the European System of Central Banks, 3. moreover, at the moment, the CNB still defines and conducts its own monetary policy but when the Czech Republic joins the Euro area, it will not have this power anymore and will conduct the single monetary policy of the Euro area under the lead of the ECB, therefore it is beneficial to study the ECB’s monetary policy by comparing it to the monetary policy of the CNB.

The issues of monetary policy of the ECB that arose in connection with the global crisis 2008 have become centre of interest of several publications and articles.4 As well the CNB’s monetary policy and foreign exchange intervention are covered in the literature and research.5 Nevertheless, legal aspects of unconventional monetary policy or monetary policy in general have not been a subject of many publications. This thesis contributes to the literature about unconventional monetary instruments, the monetary policy of the CNB and the ECB by providing the particular comparison of unconventional monetary policy instruments of the two chosen central banks with the main focus on legal aspects.

4 E.g.: DA COSTA CABRAL N., GONCALVES J., CUNHA RODRIQUEZ, N. (Eds.) The Euro and the crisis. Perspectives for the Eurozone as a Monetary and Budgetary Union. Springer International Pu- blishing, 2017. Financial and Monetary Policy Studies, vol. 43. ISBN: 978-3-319-45710-9. 5 E.g. MANDEL M., TOMŠÍK T. Monetární ekonomie v období konvergence a krize. Prague: Ma- nagement Press, 2018. ISBN: 978-80-7261-545-2; FRANTA M. et al. Měnový kurz jako nástroj při nulových úrokových sazbách: případ ČR. Research and Policy notes 3/2014. Prague: Czech National Bank, 2014. 13

Methods used in the thesis are analysis and comparison. Firstly, the practice of each of the central bank alone is examined and then the findings are compared together. Information sources relied on in the thesis are texts of legal regulation, court judgements, information published by the central banks, as well as literature concerning the topics of monetary policy and unconventional monetary policy instruments, including monographs and articles written by scholars from the relevant field.

The structure of the thesis is following. The first chapter deals with the notion of monetary policy, its regulation by the law, and aspects connected to conduct of the monetary policy by a central bank – independence of a central bank, accountability for its monetary policy. Chapter 2 and 3 focus solely on the monetary policy of the CNB, the former describing the objective of its monetary policy and monetary instruments used by the CNB, latter examining in greater detail the unconventional monetary policy instrument – the foreign exchange interventions. The fourth chapter concerns the European System of Central banks, clarifying its role, structure, and position of the ECB and the CNB within the system in order to analyse the relation between the two central banks and their monetary policies. The following chapters 5 and 6 focus on the other hand solely on the monetary policy of the ECB, chapter 5 describing briefly the objective and instruments of its monetary policy, chapter 6 examining in greater detail unconventional monetary policy instruments of the ECB. In the final chapter no. 7 findings are compared according to a set of 6 criteria regarding both economic and legal aspects: 1) aim pursued by the implemented unconventional monetary policy instrument, (2) the chosen instrument, and (3) outcome of the unconventional monetary policy, (4) power of the central banks to defined and conduct (un)conventional monetary policy, (5) the character of monetary policy decision, and (6) judicial review of a monetary policy decision of the central banks.

The author is aware that this thesis does not encompass all issues relating to (un)conventional monetary policy of the CNB and the ECB, however owing to the scope of a diploma thesis of this kind the comparison of the unconventional monetary policy of the particular central banks focuses on the mentioned 6 selected criteria. 14

1 General remarks on monetary policy

1.1 Notion of monetary policy and basic terminology

How is monetary policy defined in the broadest manner? Dr. Lastra defines monetary policy as a sum of all actions taken by monetary authorities to control the supply and cost of money and credit within a specific monetary area.6 German authors C. Herrmann and C. Dornacher define it as ‘a targeted exercise of influence on the supply of money in an economy by influencing monetary aggregates and interest rates in order to achieve specific economic goals.’7 Czech authors Z. Revenda et al. define it as an intentional activity of the highest monetary authority aiming at achieving fixed goals, mainly the goal of supporting the price stability. 8 Naturally, to define the notion of monetary policy more precisely we need to take under consideration specific monetary policy authority, the goal it is aiming to achieve and monetary processes it follows to achieve that goal. The mentioned definitions are not identical however they have the same basic idea in common. How K. Mathai puts it, even though there might be different labels for monetary policy it is simply about ‘adjusting the supply of money in the economy with the aim to achieve some combination of inflation and output stabilization’. 9 By adjusting monetary policy, the prices change in the long term where the output is fixed, however in the short term adjusting monetary policy can affect production of goods and services while the prices do not react to the adjustment so quickly. 10 It depends on the objective which a central bank is bound to pursue how the central bank balances the objectives of certain inflation and the stability of the financial sector.

6 LASTRA R. International financial and monetary law. 2nd edn. Oxford: Oxford University Press, 2015. p. 37. ISBN 9780199671090. In: HERRMANN C., CORINNA D. International and European Mone- tary Law: An Introduction. Cham: Springer, 2017. SpringerBriefs in Law. p. 93. 7 HERRMANN C., CORINNA D. International and European Monetary Law: An Introduction. Cham: Springer, 2017. SpringerBriefs in Law. p. 6. 8 REVENDA Z. et al. Peněžní ekonomie a bankovnictví. 5th ed. Prague: Management press, 2012. p. 215. 9 MATHAI K. What Is Monetary Policy? Finance & Development. 2009, vol. 46, no. 3, p. 46. 10 Ibid. 15

Each central bank, which is in most cases the authority for conducting monetary policy for certain economic area, has a mandate and a set objective (or objectives) which it must pursue by a legal document establishing the central bank. Objectives can be formulated in different manners. A central bank can have one objective to pursue, or it can have one objective set as a primary and another as a secondary objective which it pursues in case it does not interfere with the primary objective, or there can be more equal objectives set for a central bank to pursue at the same time, which is for example the case of the Federal Reserve system, the central bank of the United States of America which pursues the objectives: maximum employment, stable prices, and moderate long-term interest rates11. The particular objectives are in general the stability of monetary value (stability of prices), the pursuit of specific exchange-rates, and economic stabilisation poli- cies12 or the abovementioned objective of maximizing employment rate. The mentioned objectives of monetary policy are interrelated and can be conflicting so in actual fact a central bank must prioritise one of them. 13

When conducting monetary policy with a particular objective a central bank acts within a so-called monetary framework or monetary regime. A monetary framework gives the monetary decision making of a central bank a certain logical structure and thus ensures consistency and system to adopted measures14, moreover it helps to communicate the decision making to the public. 15 Examples of possible monetary regimes: money targeting, exchange rate targeting, inflation targeting.16 Many central banks in the world moved from money targeting to inflation targeting and there are 66 central banks (including the ECB) at present targeting inflation to achieve the goal of price stability.17 The

11 What are the Federal Reserve’s objectives in conducting monetary policy? Federal Reserve System [online]. Federal Reserve System, 2018 [cit. 2018-06-15]. 12 HERRMANN C., CORINNA D. International and European Monetary Law: An Introduction. Cham: Springer, 2017. SpringerBriefs in Law. p. 7. 13 Ibid. 14 DĚDĚK O. Doba Eura: Úspěchy i nezdary společné evropské měny. 1st ed. Prague: Linde Praha a.s., 2014, p. 40. 15 What are the regimes of monetary policy? Česká národní banka [online]. Czech National Bank, ©2003-2018 [cit. 2018-06-15]. 16 Ibid. 17 Inflation Targets. Central Bank News [online]. Central Bank News, © 2012. [cit. 2018-06-15]. 16 reason for this change is that at certain point due to innovations in the financial markets the demand for money became unstable and it began to be difficult for a central bank to control the money supply and thus the requirements for money targeting regime to work properly – ability of the central bank to control the money supply and stable correlation of money growth and inflation over time – could not be fulfilled.18 Within the inflation targeting regime, a central bank is targeting its monetary policy at inflation of an economy in order to keep it around determined level. The determined level being the expression of price stability as is the case of the ECB where the price stability is defined as an inflation rate below but close to 2 per cent.19 Inflation forecast rate is considered against the target inflation rate and the difference between these rates shows the central bank how it should react in terms of its monetary policy. To affect the inflation rate and attempt ‘close the gap’ between the forecast and target inflation rate a central bank has a variety of instruments, so-called monetary policy instruments, to implement.20 Monetary policy instruments include determination of central interest rate, minimum reserve obligations for commercial banks, and open market operations.21 We can speak about either ‘tightening’ the monetary policy when the forecast inflation rate is higher or ‘loosening’ the monetary policy when the forecast inflation rate is lower than the target rate. In the case of the central interest rate loosening of the monetary policy is based on lowering the central interest rate and tightening of the monetary policy, on the other hand, is based on increas- ing the central interest rate. However, a central bank cannot by employing monetary policy instruments directly reach the objective it is pursuing because in free market economies a central bank, neither a government of state control prices or e.g. production development.22 Measures taken by a central bank within its monetary policy are transmitted to

18 SARWAT J. Inflation Targeting: Holding the Line. International Monetary Fund [online]. International Monetary Fund, updated July 29, 2017 [cit. 2018-06-15]. 19 The definition of price stability. European Central Bank [online]. European Central Bank, copyright 2018 [citl. 2018-06-15]. 20 SARWAT J. Inflation Targeting: Holding the Line. International Monetary Fund [online]. International Monetary Fund, updated July 29, 2017 [cit. 2018-06-15]. 21 HERRMANN C., CORINNA D. International and European Monetary Law: An Introduction. Cham: Springer, 2017. SpringerBriefs in Law. p. 7. 22 HERRMANN C., CORINNA D. International and European Monetary Law: An Introduction. Cham: Springer, 2017. SpringerBriefs in Law. p. 94. 17 the real economy in order to affect it via so called transmission mechanisms. Transmis- sion mechanism works using diverse transmission channels which work simultaneously i.e. the interest rate channel, exchange rate channel, bank lending channel, balance sheet channel.23 Monetary transmission channels can be described as causal relationships transmitting the impulses from monetary policy to the real economy. A central bank employs a specific monetary policy instrument, by virtue of which it alters a specific target, e.g. central interest rate, which further affects behaviour of market participants such as commercial banks, who react on the use of the particular monetary policy instrument. 24 ‘The entire process of transmitting monetary policy to the real economy is highly complex and while the basic principle is widely accepted and understood there is no consensus among experts on the details of the mechanism’s functioning’. 25

1.2 Monetary policy and legal regulation

Monetary policy, as an economic policy of states which employ it (along with other economic policies such as the fiscal policy) to influence the macroeconomy,26 is essential for a free market economy and without functioning monetary system modern economies would incur severe consequences. 27 Thus, even though a state does not invent money through its legal acts it recognizes and regulates what is described as money by economic and social theories.28 A state has this power based on the principle of monetary sovereignty (which follows from the sovereignty of each state in general) i.e. the power to exercise an inalienable right over its currency and monetary policy. A currency being defined here as a system of monetary units, money, and means of cash-less payment such as payment cards and cheques, which circulate on a determined territory and which are

23 MATHAI K. What Is Monetary Policy? Finance & Development. 2009, vol. 46, no. 3, p. 47. 24 HERRMANN C., CORINNA D. International and European Monetary Law: An Introduction. Cham: Springer, 2017. SpringerBriefs in Law. p. 95. 25 HERRMANN C., CORINNA D. International and European Monetary Law: An Introduction. Cham: Springer, 2017. SpringerBriefs in Law. p. 95. 26 GERBER J. International Economics. 7th edition. Boston: Pearson, 2018. p. 257. 27 HERRMANN C., CORINNA D. International and European Monetary Law: An Introduction. Cham: Springer, 2017. SpringerBriefs in Law. p. 9. 28 Ibid. 18 used to meet obligations in that territory.29 Apart from the power to regulate money, a state has, within the principle of monetary sovereignty, a power to issue currency, to control monetary policy, to control exchange-rate policy and to impose exchange rate capital controls.30 The principle of monetary sovereignty is the reason why monetary matters are predominantly a national issue except for monetary unions such as the EU where the right to regulate money, control the monetary policy and issue currency is conferred on the ECB by the member states who have adopted the euro as their currency.31

Regulation of monetary policy, similarly as regulation of fiscal policy which is also an economic policy of a state, falls under the branch of financial law. Financial law is a branch of law containing legal rules which govern financial relationships and obligations and facts relating to it.32 Internally, the financial law can be structured based on the criterion of subject matter into two following parts. Fiscal part, dealing with budget law, tax law and customs, and regulation of public expenditures, and non-fiscal part dealing with matters relating to realization of powers stemming from the principle of the monetary sovereignty, and ensuring a functioning financial market.33 Accordingly, regulation of monetary matters thus falls under the non-fiscal part of financial law, whereas regulation of fiscal policy falls under the fiscal part of financial law.

How and why is monetary policy regulated by law? A state carries out monetary policy usually through a central bank. More specifically a state gives the task and competence of monetary policy to a central bank along with a certain level of discretion in monetary matters and independence. Therefore, we must look for provisions on monetary

29 TOMÁŠEK M., Evropské měnové právo. 2nd (updated) version. Prague: C. H. Beck, 2007, p. 1. 30 LASTRA R. International financial and monetary law. 2nd edn. Oxford: Oxford University Press, 2015, p. 19. ISBN 9780199671090. In: HERRMANN C., CORINNA D. International and European Mone- tary Law: An Introduction. Cham: Springer, 2017. SpringerBriefs in Law. p. 13. 31 Article 3(1)(c) of the TFEU. 32 KARFÍKOVÁ M., BOHÁČ R. Considerations about the system of financial law and financial science. In: Mrkývka P. (ed.). System of Financial Law : General Part : Conference Proceedings [online]. Brno: Masaryk University, 2015, p. 27 [cit. 2018-06-17]. 33 MRKÝVKA P. Introduction to the contemporary issues of the systém of financial law. In: Mrkývka P. (ed.). System of Financial Law : General Part : Conference Proceedings [online]. Brno: Masaryk University, 2015, p. 23 [cit. 2018-06-17]. 19 policy in legal acts regulating a central bank and its activities, e.g. in the Czech Republic in Article 98 of the Constitutional Act no. 1/1993 Coll., The Constitution of the Czech Republic, as amended by later Constitutional Acts (‘Constitution of the Czech Republic’) which concerns the Czech National Bank, and in the Act No. 6/1993 Coll., on the Czech National Bank, as amended by later acts (‘Act on the CNB’).

On one hand it is important that a central bank is independent for successfully carrying out monetary policy, as will be elaborated in next subchapter, but on the other hand it is necessary that such activity important for a state, its economy, and wellbeing of society is be regulated by law (similarly as other activities of state). As Revenda points out the independence of a central bank should not be absolute otherwise it would cause negative consequences and it should be determined by the law.34

1.3 Independence of central banks and accountability for monetary policy

The authority responsible for conducting and sometimes as well as defining monetary policy is in most countries a central bank as it was mentioned above. We can distinguish the position of a central bank in an economy depending upon the system of banks in the particular economy. It can be either one-tier or two-tier system, the former being characteristic for centrally planned economies where there is a dominant central bank which also controls the activities of commercial banks, the latter being characteristic for market economies where there is the central banking and the commercial banking separated and the central bank does not carry out the same activities which fall into the sphere of commercial banks.35 The Czech Republic is an example of a two-tier banking system. The banking system in the European Union, more precisely the Euro area is essentially a two- tier banking system as well from the functional point of view.

34 REVENDA Z. Centrální bankovnictví. 3rd edition. Prague: Management Press, 2011, p. 86. 35 REVENDA Z. Centrální bankovnictví. 3rd edition. Prague: Management Press, 2011, p. 19. 20

There is a number of attributes a central bank should represent. Some authors sum- marize these attributes to term ‘central bank good governance’ which means that ‘the objectives and tasks delegated to an institution are performed effectively and efficiently, thus avoiding misuse of resources, which is crucial for establishing a good track rec- ord.’36 These attributes are independence, transparency, and accountability.37

With regard to the monetary policy, perhaps the most important attribute and most debated one is the independence of an entity charged with this task. The entity is mostly a central bank with a certain level independence of the government. Since the eighties of the 20th century there has been a tendency to make central banks independent or to further strengthen their independence and nowadays in general, central banks of countries with a developed economy are independent of the government.38 One of the examples is the European Union, where the TFEU provides that the ECB and the national central banks of member states must be independent and gives the obligation to member states to make the statutes of national central banks and the whole national legislation compatible with this rule.39

Why is it important that a central bank is independent? There is a widely accepted opinion on the existence of a close connection between independence of a central bank and success in fighting inflation. This connection is described by Kydland-Prescott model working with three parties: the society, central bank, government, and their objectives.40 The model identifies as a key issue in fighting inflation in order to secure price stability that the government does not have a possibility to intervene into the monetary policy of the central bank because the objectives of politicians might be contrary to the optimal

36 LYBEK, T., Central Bank Autonomy, Accountability, and Governance: Conceptual Framework. In: Current Developments in Monetary and Financial Law, Vol. 4. Washington, D.C.: International Mo- netary Fund, 2005. p. 133. 37 AMTENBRINK F. The three pillars of Central Bank Governance – Towards a Model Central Bank Law or a Code of Good Governance? In: Current Developments in Monetary and Financial Law, Vol. 4. Washington, D.C.: International Monetary Fund, 2005. p. 102. 38 REVENDA Z. Centrální bankovnictví. 3rd edition. Prague: Management Press, 2011, p. 81. 39 Articles 130 – 131 of the TFEU. 40 REVENDA Z. Centrální bankovnictví. 3rd edition. Prague: Management Press, 2011, p. 82. 21 measure aiming at fighting inflation.41 As it was mentioned in the first subchapter in short run prices are fixed but output can be affected (both ways by expansive monetary policy it may grow, by restrictive monetary policy the economic growth might slow down) and only in the long term prices might changes whereas the output is fixed. Monetary policy should be in the discretion of an entity independent of the government because politicians in the government whose primary goal is to be re-elected for another term might not be impartial to the short-term benefit of expansive monetary policy and may prefer economic growth in the short term over long-term stability.42 Another argument supporting central bank independent of government is that politicians might lack the necessary expert qual- ification for decision making in the complex field of monetary policy.43

Independence of central banks may be considered from different aspects such as institutional, functional, organizational, financial.44 Also, the level of independence can be distinguished using categories of characteristics of three groups: political (e.g. ways of appointment of bank’s board members), economical (e.g. competence of the central bank in employing monetary policy instruments), financial (e.g. the budget of a central bank and related issues).45

When there is independence there must be accountability as well. Amtenbrink stresses the importance of democratic accountability of a central bank, in particular, accountability to executive and legislative power, in a constitutional system to legitimize its position.46 It is more difficult to provide mechanisms to hold a central bank accountable for its performance when it is responsible for not only conducting but also defining monetary

41 REVENDA Z. Centrální bankovnictví. 3rd edition. Prague: Management Press, 2011, p. 82. 42 AMTENBRINK F. The three pillars of Central Bank Governance – Towards a Model Central Bank Law or a Code of Good Governance? In: Current Developments in Monetary and Financial Law, Vol. 4. Washington, D.C.: International Monetary Fund, 2005. p. 103. 43 REVENDA Z. Centrální bankovnictví. 3rd edition. Prague: Management Press, 2011, p. 82. 44 AMTENBRINK F. The three pillars of Central Bank Governance – Towards a Model Central Bank Law or a Code of Good Governance? In: Current Developments in Monetary and Financial Law, Vol. 4. Washington, D.C.: International Monetary Fund, 2005. p. 104. 45 REVENDA Z. Centrální bankovnictví. 3rd edition. Prague: Management Press, 2011, p. 87. 46 AMTENBRINK F. The three pillars of Central Bank Governance – Towards a Model Central Bank Law or a Code of Good Governance? In: Current Developments in Monetary and Financial Law, Vol. 4. Washington, D.C.: International Monetary Fund, 2005. p. 104. 22 policy. 47 The question of accountability and responsibility for its performance will be further discussed in particular cases of the CNB and the ECB.

Apart from a certain level of independence which has to be granted to a central bank to carry out monetary policy it is also important to set out in the relevant legal regulation what is the main objective of monetary policy, which is mostly the price stability, and accordingly define how are central bank’s highest representatives responsible for achieving this objective. Revenda presents a unique example of the Reserve Bank of New Zea- land whose governor is personally responsible for achieving and maintaining yearly inflation rate in a designated area during his office otherwise he might be removed from his office. 48

A precondition for accountability of a central bank for its performance is transparency, there must be information available to those authorities who evaluate central bank’s activities. Transparency has yet another role and that is to provide information by a central bank about its activities to the public in order for the public to understand better its monetary policy. Moreover, the perception of the central bank’s policy by the public might affect its performance.49 In similar manner the vice-governor of the Czech National Bank described in one of his speeches interconnections between independence, transparency and perception of the public of the actions by a central bank saying that actual independence is how a central banker perceives independence which depends on the compatibility of the monetary policy regime with the preferences of the population, where the central bankers are the ones who have impact on the preferences on the population by their rhet- oric and communication to the public of monetary actions undertaken.50

47 AMTENBRINK F. The three pillars of Central Bank Governance – Towards a Model Central Bank Law or a Code of Good Governance? In: Current Developments in Monetary and Financial Law, Vol. 4. Washington, D.C.: International Monetary Fund, 2005. p. 124. 48 REVENDA Z. Centrální bankovnictví. 3rd edition. Prague: Management Press, 2011, p. 85. 49 AMTENBRINK F. The three pillars of Central Bank Governance – Towards a Model Central Bank Law or a Code of Good Governance? In: Current Developments in Monetary and Financial Law, Vol. 4. Washington, D.C.: International Monetary Fund, 2005. p. 108. 50 HAMPL M. Central Bank’s Independence in Practice: the Case of the Czech Republic [Speech at the Annual research conference of the Central Bank of Ukraine. Kiev: June 1 2018]. In: Česká národní banka [online]. © Czech National Bank, 2003-2018 [cit. 2018-06-20]. 23

2 Monetary policy of the Czech National Bank

The Czech National Bank established by Article 98(1) of the Constitution of the Czech Republic51 is the monetary authority of the Czech Republic. It has the competence to define and conduct monetary policy52 independently. Its functioning can be interfered with only on the basis of a statute. 53 Thus, it operates in accordance with provisions of the legal documents regulating it, i.e. the Constitution of the Czech Republic and the Act on the CNB.

2.1 Objective of monetary policy

The primary objective of monetary policy the CNB is pursuing is maintaining price stability as defined by Article 98(1) of the Constitution of the Czech Republic and by Article 2(1) of the Act on the CNB. Not only is the objective of maintaining price stability explicitly determined as a primary objective of the CNB, but its importance compared to other activities of the CNB is also highlighted by the fact that it is enshrined in the Con- stitution of the Czech Republic. Thus, the only possibility to make a change to this objective is by an amendment to the Constitution of the Czech Republic, moreover any other objectives of CNB’s activities enshrined only in a statute cannot be perceived as having the same importance and cannot be in conflict with the main objective of maintaining price stability. 54 Based on Article 2(1) of the Act on the CNB the CNB shall without prejudice to the primary objective of price stability support general economic policies of the Czech government leading to sustainable economic growth and general economic policies in the European Union with a purpose of contributing to the achievement of the objectives of the European Union. While pursuing the objective(s) the CNB must act in accordance with the principle of an open market economy.55

51 Article 98(1) the Constitution of the Czech Republic. 52 Article 2(2)(a) of the Act on the CNB. 53 Article 98(1) the Constitution of the Czech Republic. 54 RÝDL T. et al. Zákon o České národní bance komentář. Prague: Wolters Kluwer a.s., 2014, p 15. 55 Article 2(1) of the Act on the CNB. 24

During the time between the establishment of the CNB and today, the primary objective underwent a series of changes. The objective changed from maintaining inter- nal stability and external stability of the currency (maintaining stable exchange rate) to sole objective of maintaining the stability of the currency abandoning the objective of maintaining stable exchange rate and moving to the floating regime of the exchange rate.56 Furthermore, formulation of the primary objective of the CNB as it is formulated today was prompted by the accession of the Czech Republic to the EU due to which the Czech Republic had the obligation to harmonize its national law with the communitary legal order. Today’s objective of ’maintaining price stability’ thus replaced the former objective of ‘ensuring the stability of the Czech currency’. Formulation of the CNB’s main objective as ‘ensuring the stability of the Czech currency’ was not in accordance with the obligation of the Czech Republic stemming from its membership in the EU to adopt the single currency.57

The existence of the primary objective is set by the two aforementioned documents however its content is not defined by the law but by the CNB itself.58 The objective of the CNB’s monetary policy is quantified in form of inflation measured using consumer price index.59 Since 2010, the inflation target announced and pursued by the CNB is 2%, with possible derogation limited on 1% each way.60

2.2 Instruments

The CNB has a set of instruments available to use in order to fulfil its objective. These are, as presented by the CNB itself, open market operations, automatic facilities, liquidity providing repo operations, minimum reserves requirements, and foreign exchange

56 REVENDA Z. Centrální bankovnictví. 3rd edition. Prague: Management Press, 2011, P. 459. 57 RÝDL T. et al. Zákon o České národní bance komentář. Prague: Wolters Kluwer a.s., 2014, p 15. 58 RÝDL T. et al. Zákon o České národní bance komentář. Prague: Wolters Kluwer a.s., 2014, p 16. 59 Inflation Targeting. Česká národní banka [online]. Czech National Bank, ©2003-2018 [cit. 2018-06- 25]. 60 The CNB’s new inflation target and changes in monetary policy communication. Česká národní banka [online]. Czech National Bank, ©2003-2018 [cit. 2018-06-30]. 25 interventions.61 These can be collectively described as market, indirect, non-administrative instruments.62 Determination of instruments to be employed to carry out the monetary policy is up to the Bank Board of the CNB as provided by Article 5(1) of the Act on the CNB. Article 23 and 24 of the Act on the CNB concern monetary policy instruments, however, there is no exhaustive list of monetary policy instruments contained in the Act on the CNB. Article 23 of the Act on the CNB provides that the CNB shall set the interest rates, structures, maturities and other terms and conditions for the transactions it performs pursuant to this Act and other legislative acts. Transactions of the CNB are regulated in Articles 27 – 34 of the Act on the CNB. Article 24 of the Act on the CNB provides for obligatory minimum reserve requirements for banks, and other institutions mentioned therein.

Main monetary policy instruments of the CNB are interest rates determined by the Bank Board of the CNB. These are the two-week repo rate (‘2W repo rate’), the discount rate, and the Lombard rate.63 The discount rate is always automatically one percentage point lower than the 2W repo rate, the Lombard rate is always one percentage point higher than the 2W repo rate. In May 2010 when the 2W repo rate was lowered to 0.75 % the discount rate should have been reduced below 0 however the CNB set it on 0.25 % in that situation.64 The current level of the 2W repo rate is set at 1.5%, the discount rate is set at 0.5%, and the Lombard rate is set at 2.5%65, after the last raise of the interest rates on 27 September 2018.

The monetary policy instrument with key importance is represented by two-week repo operations (falling under the open market operations), conducted as repo tenders. In the tenders conducted by the CNB banks bid for what rate they are willing to make the

61 The main instruments of monetary policy. Česká národní banka [online]. Czech National Bank, ©2003-2018 [cit. 2018-06-30]. 62 Měnová politika České národní banky. Česká národní banka [online]. Czech National Bank, ©2003- 2018 [cit. 2018-06-30]. 63 The main instruments of monetary policy. Česká národní banka [online]. Czech National Bank, ©2003-2018 [cit. 2018-06-30]. 64 REVENDA Z. Centrální bankovnictví. 3rd edition. Prague: Management Press, 2011, p. 460. 65 The main instruments of monetary policy. Česká národní banka [online]. Czech National Bank, ©2003-2018 [cit. 2018-06-30]. 26 transaction with the CNB where the two-week repo rate is the maximum limit rate.66 Bids with lower interest rate are satisfied with priority over those with successively higher rates.67 The CNB uses this instrument to absorb liquidity from the banking sector, based on general agreement on trading on the financial market it accepts liquidity from banks in return for collateral, and after the duration of the transactions, which is 14 days, it returns the loan plus interest to the bank and the bank, on the other hand, returns the collateral.68

Supportive instruments to the two-week repo operations are the deposit and the marginal lending facilities, collectively referred to as automatic facilities, which are conducted at the discount rate, as to the former, and at the Lombard rate, as to the latter.69 The deposit facility serves to banks for depositing liquidity over night, whereas the marginal lending facility serves to banks to obtain overnight liquidity, at conditions set by the CNB.70 The discount and the Lombard rate of these facilities form a corridor within which the short-term money market rates may fluctuate.71

Liquidity-providing operations are repo operations aimed at providing liquidity to banks, currently with two-week maturity at a fixed rate of 2W repo rate plus 10 b.p.72 These were initially introduced in autumn 2008 as extraordinary measures with two-week and three-month maturities, but since January 2011 only the instrument remained only with the maturity of two weeks.73

66The main instruments of monetary policy. Česká národní banka [online]. Czech National Bank, ©2003- 2018 [cit. 2018-06-30]. 67 Ibid. 68 Ibid. 69 REVENDA Z. Centrální bankovnictví. 3rd edition. Prague: Management Press, 2011, p. 460. 70 The main instruments of monetary policy. Česká národní banka [online]. Czech National Bank, ©2003-2018 [cit. 2018-06-30]. 71 Ibid. 72 Parameters of liquidity-providing repo operations. Česká národní banka [online]. Czech National Bank, ©2003-2018 [cit. 2018-06-30]. 73 Ibid. 27

Obligatory minimum reserves are a monetary policy instrument through which the CNB can directly influence the amount of liquidity in the banking system74, however, this instrument is rather inactive because the base used for calculating the minimum reserves and interest rate for their remuneration has not changed for a long time. 75 The base is set on 2 percent since 7 October 1999, the interest rate is since July 2001 the 2W repo rate.76

Foreign exchange interventions, where the CNB purchases or sells foreign currencies against the Czech koruna, are not a standard monetary policy instrument used within the inflation targeting regime with the system of floating exchange rate. It was not used by the CNB for a long time until autumn 2013, when the Bank Board of the CNB decided to start conducting foreign exchange interventions in a situation where its main monetary policy instruments, the interest rates, were at technical zero and needed further easing of monetary policy was achieved by weakening of the exchange rate of the Czech koruna to the euro.77 Use of this unconventional monetary policy instrument by the CNB between autumn 2013 and spring 2017 is elaborated on in chapter 3. Another possible use of this instrument will come at the moment when the Czech Republic enters the ERM II mechanism and the exchange rate to euro would have to be fixed with maximum derogations of 15 % both ways.78

2.3 Independence and accountability for monetary policy

Independence of the Czech National Bank is enshrined in the legal document regulating it, in the Act on the CNB. The independence of the CNB has personal, institutional, functional, and financial aspect. Personal independence lies with the rule that the government has no power regarding appointing members of the Bank board instead they are appointed solely by the president and they can be removed from office also only by the president

74 The main instruments of monetary policy. Česká národní banka [online]. Czech National Bank, ©2003-2018 [cit. 2018-06-30]. 75 REVENDA Z. Centrální bankovnictví. 3rd edition. Prague: Management Press, 2011, p. 460. 76 The main instruments of monetary policy. Česká národní banka [online]. Czech National Bank, ©2003-2018 [cit. 2018-06-30]. 77 Ibid. 78 REVENDA Z. Centrální bankovnictví. 3rd edition. Prague: Management Press, 2011, p. 460. 28 and under specific conditions.79 The board of the Czech national bank cannot when carrying out its tasks receive instructions from the president, parliament, government or any other entity. 80 This is the expression of the institutional independence. Functional independence means that the CNB is independent on the government in formulating the inflation goals and designating instruments to apply in order to achieve the goal.81 The Bank Board formulates the monetary policy independently through adoption of monetary policy decision which it adopts in accordance with Article 5(1) of the CNB and Article 7(1) of the Act on the CNB which provides that the Bank Board of the CNB acts on simple majority of votes cast where at least the governor or a vice-governor nominated by him and three other members of the Bank Board are present. Financial independence lies with the prohibition of monetary financing enshrined in the Act on the CNB in light of the TFEU.82 Also, it means that the CNB is not funded from the public budget, but it funds its own expenses from its own revenues.83 The CNB enjoys a high level of independence but on the other hand, it is highly transparent about its monetary policy. 84

How can be the CNB be held accountable for its monetary policy and for hypo- thetical breach of provisions of the Act on the CNB? According to the Act on the CNB it shall submit a report on monetary development to the Chamber of Deputies of Parliament at least twice a year for review but this obligation of the CNB serves ‘only’ as realization of the transparency principle because the chamber of deputies does not have the power to give instructions or otherwise intervene into the formulation and conduct of monetary policy by the CNB, namely by the Bank Board which is the highest managing organ responsible for formulating and conducting monetary policy.85 Thus, in theory, the members of the Bank Board could be the ones who could be held responsible for actions taken.

79 Article 6(2), 6(10) of the Act on the CNB. 80 Article 9(1) of the Act on the CNB. 81 Proč je ČNB nezávislá? Česká národní banka [online]. Czech National Bank, ©2003-2018 [cit. 2018- 06-30]. 82 Article 34a of the Act on the CNB. 83 Article 47(2) of the Act on the CNB. 84 Proč je ČNB nezávislá? Česká národní banka [online]. Czech National Bank, ©2003-2018 [cit. 2018- 06-30]. 85 Article 5(1) of the Act on the CNB. 29

Relating to the monetary policy the Act on the CNB provides in Article 6(10) that a member of the Bank Board can be removed from the office in case he or she has committed a ‘serious misconduct’. However, it does not provide closer explanation of this term. A commentary on the Act on the CNB mentions as possible serious misconduct a ‘professional failure’ such as unfounded public announcement causing panic on financial markets or having a conflict of interest which is prohibited by the Act on the CNB.86

In connection with accountability, the question arises whether and how can be monetary policy decisions of the Bank Board of the CNB subject to judicial review for example for an alleged breach of the Act on the CNB. However, the Act on the CNB nor other act provides explicitly for judicial review of monetary policy decisions of the CNB. On the other hand, from the formulation of independence of the CNB regarding the competence of monetary policy only follows that is is independent on the executive power, and its activities can be interfered with only on a basis of a statute87, but not that it would be independent on, meaning exempt from, judicial review. Yet, there have been no cases of monetary policy decision of the Bank Board of the CNB subject to judicial review.

Observance of the prohibition of monetary financing contained in Article 34a Act on the CNB, a provision added to the Act on the CNB in connection with the accesion of the Czech Republic to the EU, is monitored by the ECB itself, which monitors on yearly basis whether the prohibition of monetary financing is in fact abided by the CNB, but it has never found the CNB in breach of this obligation in its reports.88

86 RÝDL T. et al. Zákon o České národní bance komentář. Prague: Wolters Kluwer a.s., 2014, p 51. 87 Article 98(1) of the Constitution of the Czech Republic. 88 RÝDL T. et al. Zákon o České národní bance komentář. Prague: Wolters Kluwer a.s., 2014, p 111.

3 Foreign exchange interventions of the Czech National Bank

3.1 Background

The Czech National Bank like many other central banks of the world had to, as a consequence of the 2008 financial and economic crisis and subsequent situation, employ for certain amount of time so-called unconventional monetary policy instruments in order to meet its objective of monetary policy.89 The term ‘unconventional monetary policy instrument’ can be defined as a monetary policy instrument a central bank has to implement in a situation where the short-term interest rates are on zero or close two zero level and further loosening of monetary policy is required in order to prevent deflation and meet the monetary policy objective.90

Reacting to the economic recession and decrease of inflation caused by the 2008 financial and economic crisis the CNB first, between the years 2007 – 2012, still using the conventional monetary policy instrument, reduced its interest rates for almost 4 percentage points91, the short-term repo rate getting as low as 0.05 %92. In the end of 2013, the CNB resorted to the implementation of an unconventional monetary policy instrument. This approach was motivated by the fact that the CNB loosened its monetary policy to the maximum by lowering the interest rates to ‘technical zero’93 and at the same time it was apparent from prognosis and analysis conducted by the CNB that such loosening of its monetary policy will not be sufficient to achieve its monetary policy objective.94

89 FRANTA M. et al. Měnový kurz jako nástroj při nulových úrokových sazbách: případ ČR. Research and Policy notes 3/2014. Prague: Czech National Bank, 2014, p. 4. 90 BOWDLER C., RADIA A. Unconventional monetary policy: the assessment. Oxford Review of Econo- mic Policy. 2012, vol. 28, issue no. 4, p. 603–621. 91 FRANTA M. et al. Měnový kurz jako nástroj při nulových úrokových sazbách: případ ČR. Research and Policy notes 3/2014. Prague: Czech National Bank, 2014, p. 4. 92 Changes in 2012. Czech National Bank [online]. © Czech National Bank, 2003-2018. [cit. 2018-08-08]. 93 FRANTA M. et al. Měnový kurz jako nástroj při nulových úrokových sazbách: případ ČR. Research and Policy notes 3/2014. Prague: Czech National Bank, 2014, p. 18. 94 FRANTA M. et al. Měnový kurz jako nástroj při nulových úrokových sazbách: případ ČR. Research and Policy notes 3/2014. Prague: Czech National Bank, 2014, p. 4. 31

Direct reasons for implementation of the foreign exchange interventions aimed at the de- preciation of the Czech koruna from ca. 25.60 CZK/EUR to 27 CZK/EUR were deflation pressures and decline of demand.95

3.2 Reasons for employing the unconventional monetary policy instrument

The unconventional monetary policy instrument chosen by the CNB was the exchange rate of the Czech koruna, after considering other possible options such as the forward guidance, quantitative easing, and qualitative easing.96 The CNB provides following reasons for choosing the exchange rate as the instrument to implement to react to the risk of deflation at a situation of interest rates on zero, the openness of the Czech economy, knowledge of the functioning of exchange rate transmission channel, long-term excess of liquidity in the banking sector, and relatively shallow markets with debt instruments.97 In a strict sense we must distinguish between foreign exchange interventions used as a conventional monetary policy instrument and using the exchange rate as an instrument on zero lower bound. Using foreign exchange interventions as a monetary policy instrument resides in a defined volume of interventions on the foreign exchange market, whereas its impact on the exchange rate of the relevant currency is not certainly determined. Such monetary policy is used by some central banks not only on zero lower bound. Using exchange rate as a monetary policy instrument on zero lower bound means that a central bank in questions determines and possibly also announces certain exchange rate level it is aiming to achieve and in order to achieve it intervenes on the foreign exchange market without any limitations as to the volume of the interventions. Adoption and announcement of asymmetrical exchange rate commitment done by the CNB falls into the second category and it is different from the use of conventional foreign exchange interventions

95 MANDEL M., TOMŠÍK T. Monetární ekonomie v období konvergence a krize. Prague: Management Press, 2018, p.303. 96 FRANTA M. et al. Měnový kurz jako nástroj při nulových úrokových sazbách: případ ČR. Research and Policy notes 3/2014. Prague: Czech National Bank, 2014, p. 4. 97 Ibid. 32 described in the first case. However, the literature and practice of states show that different approaches exist which lie in between the described approaches.98

3.3 Conduct of the foreign exchange interventions

After reducing the interest rates to technical zero in Autumn 2012, the CNB announced that it will keep its interest rates at that level as long as it will be necessary and at the same time it announced that if further loosening of monetary policy is necessary it will employ the exchange rate as a monetary policy instrument. 99 As the inflation rate was continuously decreasing, inflation prognoses in 2013 were showing a need for hypothet- ical negative interest rates100, and at the end of 2013, the inflation prognosis of the fourth quarter of 2013 showed a need of negative interest rate of the short-term repo rate at around 0.9 %.101 Thus, the Bank Board of the CNB decided on 7 November 2013 to further keep its interest rates at technical zero and decided to start using the exchange rate as another monetary policy instrument in order to further loosen the monetary conditions.102 The CNB would make interventions at the foreign exchange market in order to keep the exchange rate of the Czech koruna to the euro around a level of 27 CZK/EUR with no restrictions as to the time and volume of the interventions.103In a small open economy such as the Czech Republic weakening of the exchange rate has a consequence of increase of import prices, thus increase in domestic level of prices, providing support to domestic export, thus higher profitability of domestic business, and an increase in production will benefit to increase of employment and wages, thus buying power of house- holds.104 In other words weaker currency reflects in an increase of import prices which

98 FRANTA M. et al. Měnový kurz jako nástroj při nulových úrokových sazbách: případ ČR. Research and Policy notes 3/2014. Prague: Czech National Bank, 2014, p. 11. 99 FRANTA M. et al. Měnový kurz jako nástroj při nulových úrokových sazbách: případ ČR. Research and Policy notes 3/2014. Prague: Czech National Bank, 2014, p. 17. 100 Ibid. 101 Zpráva o inflaci IV/2013. Czech National Bank [online]. Prague: Czech National Bank, 2013, p.7 [cit. 2018-08-10]. 102 7. Situační zpráva o hospodářském a měnovém vývoji. 7. listopadu 2013. Czech National Bank [online]. Prague: Czech National Bank, 2013, p.7 [cit. 2018-08-10]. 103 Ibid. 104 Zpráva o inflaci IV/2013. Czech National Bank [online]. Prague: Czech National Bank, 2013, p.9 [cit. 2018-08-10]. 33 cause an increase of overall inflation, and subsequently, inflationary pressures from the domestic economy are faster restored.105 In summary, depreciating the Czech koruna by keeping the exchange rate to the euro on the level of 27 CZK/EUR helps to faster achieve the monetary policy objective, inflation at 2% and leave the zero lower bound of the CNB’s interest rates.

Two kinds of conditions were set for termination of the foreign exchange interventions of the CNB and the exchange rate commitment. Firstly, the CNB would not stop using the fixed exchange rate as a monetary policy instrument before start the of the second quarter of 2017.106 Secondly, discontinuance of the use of fixed exchange rate as a monetary policy instrument could happen only as long as fulfilment of the target of 2% inflation is sustainable and there is a high degree of certainty that the CNB will not have to return in its monetary policy to use of unconventional monetary policy instruments.107 The CNB exited the exchange rate commitment of 27 CZK/EUR on 6 April 2017 by a decision of the Bank Board of the CNB.108 On 6 April 2017 the time condition was fulfilled and as follows from the minutes of the extraordinary monetary policy meeting of the Bank Board of the CNB of that day the second condition relating to sustainable fulfilment of 2 % inflation target had been met as well.109

The final volume of the foreign exchange interventions was 2050 billions of Czech koruna110, the CNB’s foreign exchange reserves thus increased from 22% to 67% in relation to the GDP111 since the start of the foreign exchange interventions in 2013.

105 Zpráva o inflaci IV/2013. Czech National Bank [online]. Prague: Czech National Bank, 2013, p.8 [cit. 2018-08-10]. 106 BENDA V. Měnová politika v roce 2017. Česká národní banka [online]. Prague, 10.1.2017 [cit. 2018- 08-12]. 107 Ibid. 108 Prohlášení bankovní rady na tiskové konferenci po skončení mimořádného měnověpolitického zase- dání. Česká národní banka [online]. Prague: Czech National Bank, 6.4.2017 [cit. 2018-08-12]. 109 Minutes of the extraordinary monetary policy meeting of the Bank Board on 6 April 2017. Česká ná- rodní banka [online]. Czech National Bank, ©2003-2018 [cit. 2018-07-12]. 110 ALIAPULIOS J. Známe konečný účet za intervence. Na umělé oslabení koruny dala ČNB přes dva biliony. Aktuálně.cz [online]. Economia, published on 7 June 2017 [cit. 2018-08-13]. 111 MORA M., KRÁL P. Měnová politika má vždy přednost před dopady do hospodaření ČNB. Česká národní banka [online]. Czech National Bank, ©2003-2018 [cit. 2018-07-12]. 34

Termination of the use of fixed exchange rate as an unconventional monetary policy instrument meant that the exchange rate of CZK to EUR returned to the floating regime, however with the CNB prepared to intervene in case of excessive volatility of the exchange rate and return of the CNB to using only its conventional monetary policy instruments.112 Since the exit, the CNB gradually started to increase the level of its interest rates. As of today, the level of the 2W repo rate is 1.5 %.113

3.4 Legal assesment

In this section, the legality of the use of foreign exchange interventions as unconventional monetary policy instrument by the CNB is assessed. Did the CNB act within its powers and according to the law when using this unconventional monetary policy instrument?

According to Article 2 of the Act on the CNB, the main objective of the CNB is to maintain price stability. To that end, the CNB’s task is to define monetary policy114, and namely, the Bank Board is empowered to set monetary policy instruments to implement the monetary policy of the CNB.115 Therefore it is within the power of the Bank Board of the CNB to decide which monetary policy instrument to implement and how provided of course that it does not violate the law. Moreover, Article 36 of the Act on the CNB provides that the CNB has the power to trade foreign exchange and carry out all types of banking transactions in the financial market. Article 2(1) of the Act on the CNB provides that the CNB shall without prejudice to the primary objective of price stability, support the general economic policies of the Government leading to sustainable economic growth. By weakening the exchange rate of the Czech koruna the CNB supported the economic development, however, it did not act in violation of the provisions of the Constitution of the Czech Republic and the Act on the CNB because it

112 BENDA V. Měnová politika v roce 2017. Česká národní banka [online]. Prague, 10.1.2017 [cit. 2018- 08-12]. 113 Měnověpolitické nástroje ČNB – změny v roce 2018. Česká národní banka [online]. Czech National Bank, ©2003-2018 [cit. 2018-10-02]. 114 Article 2(2) of the Act on the CNB. 115 Article 5(1) of the Act on the CNB. 35 did not prejudice the primary aim of price stability.116 Neither did the CNB by use of the unconventional monetary policy violated its independence, nor any component of its independence as described in chapter 2.3.

It follows that it was within the CNB’s power to start foreign exchange interventions and adopt exchange rate commitment and by doing so it acted in accordance with its objective prescribed by the Article 98(1) of the Constitution of the Czech Republic, and Article 2(1) of the Act on CNB.

Up to date (October 2018) no monetary policy decisions of the Bank Board of the CNB relating to the use of the unconventional monetary policy instrument, the foreign exchange interventions between November 2013 and April 2017, have been subject to judicial review.

116 TOMŠÍK V., Kurzový závazek jako nástroj měnové politiky ČNB v pasti likvidity. In: Spor o měnovou politiku v kontextu měnových intervencí. Publikace č. 16/2015 Praha: Institut Václava Klause, 2015. p. 83.

4 The European System of Central Banks

The European System of Central Banks (‘ESCB’) constitutes the institutional framework of the Economic and Monetary Union (‘EMU’). It is regulated by the Treaties, and by the Protocol (No 4) on the Statute of the European System of Central Banks and of the European Central Bank annexed to the Treaties117(‘ESCB Statute’), which provide for competences and tasks relating to the EMU, in essence to carry out the obligation of the Union enshrined in Article 3(4) of the Treaty on European Union118(‘TEU’): ‘The Union shall establish an economic and monetary union whose currency is the euro’. Naturally, one of the main tasks of the ESCB is to define and carry out monetary policy. However, at the present point not all member states of the European Union have adopted euro, as is the case of the Czech Republic. That difference between member states reflects on the structure of the ESCB.

4.1 Economic and Monetary Union

EMU is a result of years-long evolution. Following the initial steps of European integration, the creation of EMU was a way to deepen the economic integration. A stable monetary system contributes to peace and prosperity which was especially important aspect after the end of World War II and subsequent events such as break-down of the Bretton Woods par value system. 119

Economic integration started as a free trade area, later customs union and the ultimate goal set by the EEC treaty was a single market. A single market with free movement of goods, capital, services, and labour. Grounds for the Single market were laid down in the Single European Act adopted in 1986. In pursuance of the credo ‘one market needs one money’, and in accordance with warnings of economists that

117 Protocol (No 4) on the Statute of the European System of Central Banks and of the European Central Bank annexed to consolidated versions of the Treaty on European Union and the Treaty on the Fun- ctioning of the European Union. O.J. C 202/230, 7.6.2016. 118 Consolidated version of the Treaty on European Union, O.J. C 202/13, 7.6.2016. 119 HERRMANN C., CORINNA D. International and European Monetary Law: An Introduction. Cham: Springer, 2017. SpringerBriefs in Law. p. 63. 37 consequences of a single market were inconsistent with independent national monetary policies 120 in 1988 the European Council instructed the Delors Committee to undergo a study of possible ways to realise the EMU. 121 The result, embodied in the Delors report, was a three-stage process for the establishment of the EMU with institutional structure of European System of Central Banks.122 The ideas of the Delors committee lead to negotiation of the Maastricht treaty which was adopted in 1992 and implemented the process for establishing EMU as envisaged by the Delors report. 123

The three stages to reach the EMU were following: First took place from 1st July 1990 until 31st December 1993 and its aim was the full achievement of the single market. The second took place from 1st January 1994 until 31st December 1998. During which the eleven initial members of the EU had to complete convergence criteria introduced by the Maastricht treaty, enshrined in Article 121 of the EC Treaty, now Article 140 of the TFEU, avoid excessive budget deficits as provided Article 104 of the EC Treaty, now Article of the 126 TFEU, and reform national legislation regarding national central banks according to Articles 108, 109 of the EC Treaty, today Article 130, 131 of the TFEU, and according to the ESCB Statute, all for the purpose of actual establishment of ESCB. The second stage was where the single currency got its name ‘euro’ as was decided by heads of states or governments of relevant member states. The third stage started on 1st January 1999 and it is still ongoing. The core of stage three was determination of exchange rates of the eleven member states’ currencies to euro and irrevocable fixation thereof by 1999 followed by the introduction of euro as a single currency however only in intangible form. Only since 1st January 2002 euro coins and banknotes were introduced. Consequently, the

120 HERRMANN C., CORINNA D. International and European Monetary Law: An Introduction. Cham: Springer, 2017. SpringerBriefs in Law. p. 70. 121 The European Central Bank, The Eurosystem, The European System of Central Banks. Frankfurt am Main: European Central Bank, 2008. p. 5. 122 HERRMANN C., CORINNA D. International and European Monetary Law: An Introduction. Cham: Springer, 2017. SpringerBriefs in Law. p. 70. 123 Ibid. 38

European Central Bank and the ESCB acquired the competence and responsibility for the monetary policy.124

At the present point, not all member states of the EU have adopted the euro. Between the beginning of stage three where 11 members adopted euro and presence another eight member states have adopted euro and they form the Eurosystem. From the remaining nine member states of the EU which are not part of the Eurosystem seven are yet to fulfil the convergence criteria and become part of the Eurosystem, the UK125 and Denmark126 obtained so-called opt-out and do not have an obligation to become part of the Eurosystem. Those member states who do not possess the opt-out right and are not yet part of the Eurosystem are called in terms of the TFEU ‘member states with a derogation’.127 They remain with this status until the European Council decides they fulfil the criteria following from the Article of the140 TFEU. These are conformity of national legislation with the Treaties and the ESCB Statute as provided by Article 131 of the TFEU and criterion of independence of the national central bank as provided by Article 130 of the TFEU, and fulfilment of convergence criteria contained in Article 140 of the TFEU and detailed in Protocol (No 12) on the excessive deficit procedure annexed to the TEU and the TFEU128 and Protocol (No 13) on the convergence criteria annexed to the TEU and the TFEU129. Those convergence criteria are first, achievement of a high degree of price stability which is demonstrated by inflation rate not more than 1.5 percent higher

124 HERRMANN C., CORINNA D. International and European Monetary Law: An Introduction. Cham: Springer, 2017. SpringerBriefs in Law. p. 71. 125 Protocol (No 15) on certain provisions relating to the United Kingdom of Great Britain and Northern Ireland annexed to consolidated versions of the Treaty on European Union and the Treaty on the Fun- ctioning of the European Union. O.J. C 202/284, 7.6.2016. 126 Protocol (No 16) on certain provisions relating to Denmark annexed to consolidated versions of the Treaty on European Union and the Treaty on the Functioning of the European Union. O.J. C 202/287, 7.6.2016. 127 Article 139 of the TFEU. 128 Protocol (No 12) on the excessive deficit procedure annexed to consolidated versions of the Treaty on European Union and the Treaty on the Functioning of the European Union. O.J. C 202/279, 7.6.2016. (‘Protocol on the excessive deficit procedure’) 129 Protocol (No 13) on the convergence criteria annexed to consolidated versions of the Treaty on Euro- pean Union and the Treaty on the Functioning of the European Union. O.J. C 202/281, 7.6.2016. (‘Protocol on the convergence criteria’) 39 than the average of the lowest inflation rates of the member states130, second, achieving a government budgetary position where the planned or actual governmental deficit does not exceed 3 percent of GDP at market prices, and where the government debt does not exceed 60 percent of the GDP at market prices131, third, joining the exchange rate mechanism and observe the normal fluctuation margins at least for two years without devaluating against the euro, fourth, observe for over a period of one year before the examination of fulfilling the criterion, that average nominal long-term interest rate that does not exceed by more than two percentage points that of, at most, the three best performing member States in terms of price stability.132

Although the term Economic and Monetary Union is used above and is similarly used by the Treaties, only existence of Monetary Union is a fact (still without all the member states participating). As for now, Economic Union is merely a coordination of particular policies133 whereas for example control over fiscal policies is retained solely by each of the member states.

The current situation with different relation of member states towards the monetary union reflects as well to the institutional framework of the monetary union which is due to that reason internally differentiated and will remain so until all the relevant member states will become part of the monetary union.

4.2 Structure and tasks of the ESCB

The European System of Central Banks is composed of the European Central Bank and national central banks of all, currently 28, member states of the EU134. This setup can be characterized as a decentralized central banking system, with a centralized governance of the ECB, namely its decision-making bodies as follows from the Articles 129(1) and

130 Article 1 of the Protocol on the convergence criteria. 131 Article 1 of the Protocol on the excessive deficit procedure. 132 Article 4 of the Protocol on the convergence criteria. 133 Article 5(1) of the TFEU. 134 Article 282.1 of the TFEU, Article 1 of the ESCB Statute. 40

282(2) of the TFEU and Article 8 of the ESCB Statute. 135 Unlike from the ECB, the ESCB does not possesses legal personality and can be perceived rather as joint operation of the national central banks and the ECB.136

Primary objective of the ESCB is according to Article 127 (1) of the TFEU to maintain price stability, and without prejudice to the primary objective it shall support the general economic policies in the Union with a view to contributing to the achievement of the objectives of the EU as laid down in Article 3 of the TEU. Its basic tasks are defined in Article 127(2) of the TFEU which are to define and implement monetary policy of the Union, conduct foreign-exchange operations, to hold and manage the official foreign reserves of the member states, and to promote the smooth operation of payment systems. Even though Article 127 of the TFEU prescribes the mentioned objective and tasks to the whole ESCB, by virtue of Article 139 of the TFEU the objective and tasks of the ESCB (among others) do not apply on the member states who have not yet adopted the euro. Accordingly, the conduct of the monetary policy of the EU is explicitly entrusted to the Eurosystem by Article 282(1) of the TFEU. The Eurosystem is formed by the ECB together with the national central banks of those member states who adopted the euro. As for today (October 2018), there are 19.137 Article 282(4) of the TFEU on the other hand explicitly provides that member states who had not adopted the euro, and the particular national central banks retain their powers in monetary matters.

The decision-making bodies of the ECB governing the ESCB, or in terms of the monetary policy governing the Eurosystem, are the Governing Council and Executive Board.138 The Governing Council comprises Governors of national central banks of the Eurosystem and the President of the ECB, the Vice-President of the ECB, and other four members of the Executive Board of the ECB.139 The Executive Board comprises the

135 HERRMANN C., CORINNA D. International and European Monetary Law: An Introduction. Cham: Springer, 2017. SpringerBriefs in Law. p. 74. 136 HERRMANN C., CORINNA D. International and European Monetary Law: An Introduction. Cham: Springer, 2017. SpringerBriefs in Law. p. 76. 137 Article 282(1) of the TFEU, Article 1 of the ESCB Statute. 138 Article 283 of the TFEU. 139 Article 283(1) of the TFEU. 41

President of the ECB, the Vice-President of the ECB and four other members. All six members of the Executive Board are appointed by the European Council for an office term of eight years.140 The current President of the ECB is Mario Draghi since 1st November 2011.141 Division of responsibilities between the Governing Council and the Executive board is provided in Article 12 of the ESCB Statute. The Governing Council is the decision-making body of the ESCB strictly speaking because it is responsible for adopting guidelines and decisions necessary to carry out tasks as imposed on the ESCB by the Treaties and the ESCB Statute, including formulating the monetary policy, whereas the Executive Board’s responsibility is to implement monetary policy as formulated by the Governing Council in its guidelines and decisions.142 Both the Governing Council and the Executive Board are as decision-making bodies of the ECB entitled to make regulations, take decisions, make recommendations and deliver options as provided by Article of the 132(1)TFEU and thus perform the ECB’s authority to legislate.143

Reflecting the situation where not all member states of the EU have the euro as a currency the TFEU and the ESCB Statute provide for third-decision making body, the General Council of the ECB. 144 The General Council is established as a temporary body which will exist until all members of the EU are at the same time members of the Eurozone.145 The General Council comprises the President and the Vice-President of the ECB, and governors of national central banks of all member states.146 Its responsibilities enumerated in Article 46 of the ESCB Statute are of coordinative and preparatory character in regard to the monetary union.147

140 Article 11(1), 11(2) of the ESCB Statute. 141 Executive Board Members - terms of office. European Central Bank [online]. European Central bank, copyright 2018 [cit. 2018-08-20]. 142 Article 12(1) of the ESCB Statute. 143 HERRMANN C., CORINNA D. International and European Monetary Law: An Introduction. Cham: Springer, 2017. SpringerBriefs in Law. p. 78. 144 Article 141(1) of the TFEU, Article 44 of the ESCB Statute. 145 Article 141(1) of the TFEU. 146 Article 44(2) of the ESCB Statute. 147 LASTRA R. International financial and monetary law. 2nd edn. Oxford: Oxford University Press, 2015. p 251. ISBN 9780199671090. In: HERRMANN C., CORINNA D. International and European Monetary Law: An Introduction. Cham: Springer, 2017. SpringerBriefs in Law. p. 75. 42

4.3 Position of the Czech National Bank within the ESCB

The Czech Republic accessed to the European Union on 1st May 2004 by virtue of the Treaty of Accession of 23rd September 2003.148 By the accession of the Czech Republic to the EU the Czech National Bank became part of the ESCB.149 The Czech Republic has not yet adopted the single currency however it has the obligation to do so pursuant to Article 3 of the TEU and Article 119 of the TFEU since the adoption of the single currency and economic and monetary union are one of the aims of the whole EU. The Czech Republic did not negotiate an exception to the Treaties regarding the adoption of the single currency, thus it is obliged to adopt it, however, there is no certain deadline set. The Act concerning the conditions of accession of the Czech Republic,(…), and the adjustments to the Treaties on which the European Union is founded, namely Article 4, granted the Czech Republic temporary exception from the Treaties, meaning that from the date of its accession to the EU it participates in the EMU as a member state with a derogation within the meaning of current Article 139 of the TFEU150.

Consequently, currently the participation of the central bank of the Czech Republic, the Czech National Bank in the ESCB consists of membership of the governor of the CNB in the General Council of the European Union, and in participation of employees of the CNB on the meetings of ESCB committees151 when an ESCB committee deals with matters falling under the competence of the General Council.152 While the Czech Republic is a member state outside the Euro area obligations of the CNB in relation to the ESCB are following. The CNB had to contribute to the operational costs

148 Treaty of Accession of the Czech Republic, Estonia, Cyprus, Latvia, Lithuania, Hungary, Malta, Po- land, Slovenia and Slovakia. O.J. L 236, 23.9.2003. 149 Article 282(1) of the TFEU, Article 1 of the ESCB Statute. 150 Article 4 of the Act concerning the conditions of accession of the Czech Republic, the Republic of Es- tonia, the Republic of Cyprus, the Republic of Latvia, the Republic of Lithuania, the Republic of Hun- gary, the Republic of Malta, the Republic of Poland, the Republic of Slovenia and the Slovak Repub- lic, and the adjustments to the Treaties on which the European Union is founded. O.J. L 236/33, 23.9.2009. 151 Evropský systém centrálních bank - jaké jsou úkoly ČNB? Česká národní banka [online]. Czech Nati- onal Bank, ©2003-2018 [cit. 2018-10-02]. 152 The European Central Bank, The Eurosystem, The European System of Central Banks. Frankfurt am Main: European Central Bank, 2008. p. 19.

43 incurred by the ECB in relation to the participation of the CNB in the ESCB. That contribution represents a small part of the share of the CNB in the ECB’s subscribed capital.153 The CNB has obligations regarding the tasks of the General Council154 and obligation to consult the ECB in cases prescribed by Article 127(4) of the TFEU.

Based on the fact that currently the Czech Republic is a member state with a derogation in the meaning of the Article 139 TFEU, until the time the Czech Republic fulfils conditions of Article 140 of the TFEU and enters the Eurozone it will not be participating through the CNB on the monetary matters of the EU while it will retain full sovereignty over its monetary matters. From the moment the Czech Republic enters the Eurozone, the CNB will become part of the Eurosystem, the exception of Article 139 of the TFEU will not be applicable anymore and in accordance with the TFEU and the ESCB Statute, the CNB will be participating on the conduct of the monetary policy of the Eurosystem. Meaning that all competencies regarding monetary policy will pass from the CNB to the ECB. The CNB will be acting in matters of monetary policy under the decisions of the Governing Council where one of its members will be the governor of the CNB. The CNB will thus become, ‘executive’ branch of the ECB in carrying out the monetary policy of the Eurosystem.

Currently, the Czech Republic is fulfilling 3 of the 5 convergence criteria. That follows from the 2017 Report on fulfilment of the Maastricht convergence criteria and level of economic synchronization with EU, prepared by the Ministry of Finance of the Czech Republic and the CNB.155 This report serving as a guidance for the Czech government’s decision on setting the date of adoption of the single currency, recommends the government not to set the certain date as of yet and not take steps aiming at entering

153 Capital subscription. European Central Bank [online]. European Central Bank, copyright 2018 [cit. 2018-08-23]. 154 Article 46 of the ESCB Statute. 155 Vyhodnocení plnění maastrichtských konvergenčních kritérií a stupně ekonomické sladěnosti ČR s eu- rozónou. Ministerstvo financí České republiky [online]. Prague, Ministry of finance of the Czech Re- public, Czech National Bank, December 2017 [cit. 2018-09-08]. 44 the ERM II. 156 The current government, which will be in office until the year 2021, stated that it does not see a possibility to access to the Eurozone at the present moment and that it will not strive for adoption of the single currency because of the unfinished convergence process, loss of sovereignty over the monetary matters, and obligation to contribute the relevant sum of ca. billions of CZK into the European Stabilization Mechanism.157 Thus it remains uncertain when the Czech Republic will become part of the Eurozone and the CNB will become part of the Eurosystem and as a consequence will lose its competence over defining and conduct of monetary policy.

156 Vyhodnocení plnění maastrichtských konvergenčních kritérií a stupně ekonomické sladěnosti ČR s eu- rozónou. Ministerstvo financí České republiky [online]. Prague, Ministry of finance of the Czech Re- public, Czech National Bank, December 2017, p. 2 [cit. 2018-09-08]. 157 Policy Sstatement of the Government of the Czech Republic. Vláda České republiky [online]. Vláda ČR (c) 2009-2018. [cit. 2018-09-08]. 45

5 Monetary policy of the European Central Bank

Monetary policy for the member states whose currency is the euro is within the exclusive competence of the EU.158 According to Article 2(1) of the TFEU, only relevant bodies of the EU may adopt legally binding acts in the area of monetary policy whereas the member states can only do so if they are empowered by the EU or they do so in order for implementing an act of the EU in that area.159 However, monetary policy is not defined anywhere in the Treaties, nor in the ESCB Statute, therefore to determine whether a measure adopted by the EU bodies falls within the area of monetary policy, thus within the scope of conferred powers, i.e. the exclusive competence of the EU, it must be referred principally to objectives of the measure but the instruments the measure employs to achieve the objective are relevant, too.160

The ECB established on 1st June 1998, 161 which unlike from the ESCB, possesses legal personality, 162 is one of the institutions of the EU163, and can be sued at the European Court of Justice, 164 governs the ESCB through its decision making bodies.165 The Governing Council formulates the monetary policy by adopting decisions and guidelines166 aimed at achieving the objective of maintaining price stability entrusted to the ESCB, 167 and the Executive Board168 implements it through instructions given to the NCBs of the Eurosystem in accordance with the decisions and guidelines of the Governing Council.

158 Article 3(1)c of the TFEU. 159 HERRMANN C., CORINNA D. International and European Monetary Law: An Introduction. Cham: Springer, 2017. SpringerBriefs in Law. p. 95. 160 Judgement of the Court (Grand Chamber) of 16 June 2015, Gauweiler, Case C-62/14 (‘Gauweiler‘), para. 46, Judgement of the Court (full Court) of 27 November 2012, Pringle, Case C-370/12 (‘Prin- gle’), para. 53 and paras. 56 -57. 161 Economic and Monetary Union (EMU). Europan Central Bank [online]. European Central bank, Cop- yright 2018 [cit. 2018-07-24]. 162 Article 282(3) of the TFEU. 163 Article 13(1) of the TEU. 164 Article 35 of the ESCB Statute. 165 Article 282(2) of the TFEU, Article 8 of the ESCB Statute. 166 Article 12(1) of the ESCB Statute. 167 Article 127(1), Article 282(2) of the TFEU, Article 2 of the ESCB Statute. 168 Article 12(1) of the ESCB Statute. 46

5.1 Objective of monetary policy

The primary objective of the monetary policy the ECB shall pursue is maintaining price stability, as provided by the TFEU169, the ESCB Statute170. Without prejudice to the primary objective the general economic policies in the EU shall be supported, in accordance with the principle of an open market economy with free competition, and with a view to contributing to the achievement of the objectives of the EU as laid down in Article 3 of the TEU171. Moreover, according to Article 119(4) of the TFEU guiding principles with which the monetary policy must be in compliance are stable prices, sound public finances, and monetary conditions and sustainable balance of payments. The primary objective of price stability is quantified as inflation rate below, but close to, 2% over the medium term, where inflation is defined as a year-on-year increase in consumer prices measured by the Harmonised Index of Consumer Prices, which is an index harmonized across euro area member states.172 It has been defined in this manner by the ECB since its establishment in 1998.173

5.2 Instruments

Instruments which the ECB uses to transmit its monetary policy to the economy are mentioned in the ESCB Statute in Articles 17 to 19. However, they do not constitute an exhaustive list of instruments which the ECB has because Article 20 of the ESCB Statute provides for a possibility of the Governing Council to decide upon the use of other instruments it sees fit in order to fulfil the objectives as set out by Article 2 of the ESCB Statute.

The instruments used by the ECB, which are also referred to together as operational framework of the Eurosystem, are open market operations, provided for by Article 18 of the ESCB Statute, standing facilities, provided for by Article 17 of the ESCB

169 Article 119(2), 127(1), 282(2) of the TFEU. 170 Article 2 of the ESCB Statute. 171 Article 119(2) 127(1), 282(2) of the TFEU, Article 2 of the ESCB Statute. 172 ECB. The Monetary Policy of the ECB. Frankfurt am Main: European Central Bank, 2011, p.9. 173 Ibid. 47

Statute, minimum reserve requirements for credit institutions, provided for by Article 19 of the ESCB Statute, and since the year 2009 several unconventional monetary policy measures i.e. asset purchase programmes.174

Essential for the ECB’s monetary policy is the determination of the key interest rates, i.e. interest rates for main refinancing operations, and standing facilities. The current key interest rates since 16th March 2016 are for deposit facility – 0.40 %, for main refinancing operations 0.00 %, for marginal lending facility 0.25 %.175

Open market operations are operations conducted on the initiative of the ECB usually in the money market i.e. a market where the maturity of transactions is in general less than one year and include main refinancing operations, long-term refinancing operations, fine-tuning operations, and structural operations.176 Main refinancing operations, which represent the key monetary instrument of the Eurosystem, reside in providing liquidity to the financial sector by lending against adequate collateral in form of reverse transactions.177 Their frequency and maturity is normally one week.178 The main refinancing operations are carried out by the NCBs (in accordance with the principle of decentralized implementation of ESCB’s monetary policy) in form of standard tenders according to an indicative calendar which the ECB publishes on its website.179 Here, a reverse transaction means a transaction where the NCB buys assets under a repurchase agreement or lends funds against a collateral, they are temporary open market operations which provide funds for a limited time specified in advance.180

174 The Eurosystem’s instruments. European Central Bank [online]. European Central Bank, copyright 2018 [cit. 2018-07-23]. 175 Monetary policy decisions [press release]. European Central Bank [online]. European Central Bank, 10 March 2016 [cit. 2018-07-23]. 176 ECB. The Monetary Policy of the ECB. Frankfurt am Main: European Central Bank, 2011, p.96. 177 ECB. The Monetary Policy of the ECB. Frankfurt am Main: European Central Bank, 2011, p. 96, 98. 178 The Eurosystem’s instruments. European Central Bank [online]. European Central Bank, copyright 2018 [cit. 2018-07-23]. 179 The Eurosystem’s instruments. European Central Bank [online]. European Central Bank, copyright 2018 [cit. 2018-07-23]. 180 ECB. The Monetary Policy of the ECB. Frankfurt am Main: European Central Bank, 2011, p. 99. 48

Standing facilities are available at the own initiative of ECB’s counterparties.181 The two standing facilities, marginal lending facility and deposit facility serve at providing, in case of the former, and absorbing, in the case of the latter, liquidity overnight.182 The interest rate of the marginal lending facility and deposit facility make a corridor within which the short-term interest rates can fluctuate.183 This way the ECB can control the short-term interest rates in the money market.184

Minimum reserve requirements have two basic functions: 1) To pursue the aim of stabilizing money market interest rates, 2) to enlarge the structural liquidity shortage of the banking system.185 Credit institutions in the euro area must hold minimum reserves on account with a relevant NCB186, where the ‘compliance with the reserve requirement is determined on the basis of the institutions' average daily reserve holdings over a maintenance period of about one month.’187 The amount is determined by multiplication of reserve base by reserve ratio, where the reserve base of a credit institution is determined based on certain elements in its balance sheet. There is positive reserve ratio set at 2% and zero reserve ratio, each applying to different items of the reserve base.188

Various asset purchase programmes have been implemented since 2009 as unconventional monetary policy instruments to complement the above mentioned conventional monetary policy instruments.189 These will be addressed in the following chapter separately and in greater detail.

181 The Eurosystem’s instruments. European Central Bank [online]. European Central Bank, copyright 2018 [cit. 2018-07-23]. 182 Ibid. 183 ECB. The Monetary Policy of the ECB. Frankfurt am Main: European Central Bank, 2011, p. 100. 184 ECB. The Monetary Policy of the ECB. Frankfurt am Main: European Central Bank, 2011, p. 99. 185 The Eurosystem’s instruments. European Central Bank [online]. European Central Bank, copyright 2018 [cit. 2018-07-23]. 186 ECB. The Monetary Policy of the ECB. Frankfurt am Main: European Central Bank, 2011, p. 102. 187 The Eurosystem’s instruments. European Central Bank [online]. European Central Bank, copyright 2018 [cit. 2018-07-23]. 188ECB. The Monetary Policy of the ECB. Frankfurt am Main: European Central Bank, 2011, p. 102. 189 The Eurosystem’s instruments. European Central Bank [online]. European Central Bank, copyright 2018 [cit. 2018-07-23]. 49

5.3 Independence and accountability for monetary policy

Independence of the ECB is enshrined in article 282(3) of the TFEU: ‘(…)It shall be independent in the exercise of its powers and in the management of its finances. Union institutions, bodies, offices and agencies and the governments of the Member States shall respect that independence.’. There are 4 aspects of independence provided by the TFEU which also apply on the national central banks of member states (‘NCB’) by virtue of Article 131 of the TFEU. Pursuant to Article 130 of the TFEU the institutional independence means that the ECB is prohibited to take or seek instructions when carrying out its tasks from Union institutions, bodies, offices or agencies, from any government of a Member State or from any other body. The main objective of the monetary policy must be only the price stability as provided by article 127(1) of the TFEU expressing the ECBS’s functional independence. Accordingly, the Governing Council of the ECB decides independently and with broad discretion on monetary policy in accordance with rules of Article 20 of the ESCB Statute which provides that: ‘The Governing Council may, by a majority of two thirds of the votes cast, decide upon the use of such other operational methods of monetary control as it sees fit, respecting Article 2‘. The aspect of personal independence lies in the rule that members of the executive board of the ECB are appointed by the European Council following prescribed procedure to eliminate political pressures190 and may be dismissed only for specific reasons as laid down in Article 14(2) of the ESCB Statute. The financial aspect of independence is enshrined in Article 123 of the TFEU providing for prohibition of monetary financing of the EU institutions, bodies, offices or agencies, central governments, regional, local or other public authorities, other bodies governed by public law.

The ESCB Statute provides in Article 35(1) that acts or omissions of ECB fall under the judicial review of the Court of Justice of the European Union. Moreover, the ESCB Statute provides in Article 35(3) that the ECB shall be subject to liability regime under Article 340 of the TFEU. The fact that independence of the ECB does not

190 Article 282(2) of the TFEU. 50 absolutely shield it from any kind of community rule or judicial review was elaborated in decision of the Court of Justice in case C-11/00 Commission v ECB191 declaring that it is subject not only to the judicial review by the Court of Justice but also by the Court of Auditors and that the intention of the draftsmen of the Treaties was not to shield the ECB from any kind of legislative action taken by the Community legislature. As well as making it clear that the ECB must act within the limits conferred upon it by the Treaties meaning that the principle of independence does not shield the ECB further than on actions taken within the said limits. 192

191 Judgement of the Court of 10 July 2003, Commission v ECB, Case C-11/00. (‘Comission v ECB’) 192 Comission v ECB, para. 135. 51

6 Non-standard monetary policy measures of the ECB

6.1 Background

Reacting to the effects the financial and economic crisis of 2008 had on the situation in Eurozone the ECB had to complement its operational framework by a set of unconventional monetary policy instruments, or in the terminology of the ECB ‘non- standard monetary policy measures’193, in order to fulfil its objective. In that situation use of usual monetary policy instruments of the ECB became ineffective due to two reasons. 1) when key interest rates fall down to zero, there is no further possibility to ease monetary policy using this instrument. That situation occurred in case of the ECB in May of 2009 – main refinancing operation rate decreased to 1%, and deposit facility rate decreased on 0.25 %. 2) The transmission channels of the monetary transmission mechanism stopped working. During a crisis there is distrust between participants on interbank market, they stop lending funds to each other and thus the role of key interest rates of a central bank loses its sense because there is nobody acting according to them and they cannot have the desired effect the monetary policy authority aimed at. And this situation is exactly what happened after the fall of the Lehman Brothers investment bank in September of 2008, the interbank money market was paralysed.194

6.2 Applied unconventional monetary policy instruments

The ECB firstly reacted, still within the standard operational framework, by reducing the key interest rates, to address receding inflationary pressures, in accordance with its mandate to pursue the objective of price stability.195 Secondly, the ECB had to deal with

193 The Eurosystem’s instruments. European Central Bank [online]. European Central Bank, copyright 2018 [cit. 2018-07-23]. 194 DĚDĚK O. Doba Eura: Úspěchy i nezdary společné evropské měny. 1st ed. Prague: Linde Praha a.s., 2014, p. 260. 195 STARK J. Monetary Policy before, during and after the financial crisis [speech at University Tü- bingen, Tübingen, 9 November 2009]. Europan Central Bank [online]. European Cental Bank, copyright 2018. [cit. 2018-08-02]. 52 an issue of paralysed interbank money markets in the eurozone, caused by distrust between the market’s participants who were thus reluctant to lend each other after the fall of the Lehman Brothers investment bank which started the global economic and financial crisis in September 2008. 196 To deal with the problem of paralysed interbank money markets, whose proper functioning is essential for ECB’s monetary policy to have the desired effect, the ECB embarked on set of non-standard measures later referred to collectively as enhanced credit support.197 The role of the interbank markets in the Euro area is essential, the financial sector cannot work without functioning interbank money markets because then it cannot supply the economy with credit. Since it did not work, the ECB had to assume the functions of interbank money markets. 198

The enhanced credit support consisted of extension of the maturity of liquidity provision, i.e. extension of the maturity of long-term refinancing operation to twelve months, a fixed rate full allotment procedure for all refinancing operations meaning that subject to adequate collateral, banks had unlimited access to liquidity, currency swap agreements, relaxing collateral requirements (qualitative easing)199, and covered bond purchase programme aimed at supporting the covered bond market by the Eurosystem purchasing euro-denominated covered bonds for 60 billion euro between May 2009 and June 2010.200

Moreover, the ECB was in a more difficult position than other central banks because besides the economic and financial crisis, the sovereign debt crisis affected the eurozone.201 To address tensions in the public and private debt securities markets the ECB

196 STARK J. Monetary Policy before, during and after the financial crisis [speech at University Tü- bingen, Tübingen, 9 November 2009]. Europan Central Bank [online]. European Cental Bank, copyright 2018. [cit. 2018-08-02]. 197 Ibid. 198 Ibid. 199 HERRMANN C., CORINNA D. International and European Monetary Law: An Introduction. Cham: Springer, 2017. SpringerBriefs in Law. p. 131. 200 ECB. The Monetary Policy of the ECB. Frankfurt am Main: European Central Bank, 2011, p. 127. 201 DĚDĚK O. Doba Eura: Úspěchy i nezdary společné evropské měny. 1st ed. Prague: Linde Praha a.s., 2014, p. 260. 53 introduced on 14 May 2010202 the Securities Markets Programme (‘SMP’) with the objective to ensure depth and liquidity in dysfunctional segments of the markets and restore appropriate monetary policy transmission mechanism.203 The SMP was an open market operation falling under Article 18(1) of the ESCB Statute, for a limited amount of time with purchases taking place between May 2010 and September 2012. 204 In accordance with Article 123 of the TFEU purchase of the government bonds were strictly limited to the secondary market.205 At the same time, the ECB conducted liquidity absorbing operations to sterilise the impact of the liquidity provided by the programme to ensure that liquidity conditions are not affected.206 The SMP, designed for a limited amount of time and a limited amount of bonds, differs from large-scale purchase programmes referred to as quantitative easing purpose of which is the expansion of the monetary base.207 By announcing that within the SMP the ECB would buy government bonds only for limited amount of time, holders of government bonds were motivated to sell those as quickly as possible which resulted in the ECB having to buy a lot of them for about 165 billion of euro. 208

The SMP was terminated by the announcement of technical features of Outright Monetary Transactions (‘OMTs’) programme on 12 September 2012.209 The Governing Council of the ECB announced that the OMT’s would be outright transactions in secondary sovereign bond markets aiming at safeguarding an appropriate monetary policy transmission and the singleness of the monetary policy, with the start, continuation, and

202 Decision of the European Central Bank ECB/2010/5 of 14 May 2010 establishing a securities market programme. 203 ECB decides on measures to address severe tensions in financial markets [press release]. European Central Bank [online]. European Central Bank, copyright 2018 [2018-08-04]. 204 HERRMANN C., CORINNA D. International and European Monetary Law: An Introduction. Cham: Springer, 2017. SpringerBriefs in Law. p. 132. 205 ECB. The Monetary Policy of the ECB. Frankfurt am Main: European Central Bank, 2011, p. 128. 206 Ibid. 207 HERRMANN C., CORINNA D. International and European Monetary Law: An Introduction. Cham: Springer, 2017. SpringerBriefs in Law. p. 133. 208 DE GRAUWE P. Economics of Monetary Union.11th ed. Oxford: Oxford University Press, 2016, p. 210 – 211. 209Technical features of Outright Monetary Transactions [press release]. European Central Bank [online]. European Central Bank published 6 September 2012 [cit. 2018-08-04]. 54 suspension of the OMTs in full discretion of the Governing Council and no-ex ante quantitative limits set on the volume of the transactions. 210 The OMT’s were made conditional upon the issuing state of the respective bond to be taking part in European Financial Stability Facility or European Stability Mechanism programme, in form of a full macroeconomic adjustment programme or a precautionary programme. 211 The purchases under the OMT programme would cover sovereign bonds with a maturity of between one and three years, the ECB would not have any special treatment regarding the purchased bonds, and the liquidity injected to the system by ECB through the OMT’s would be fully sterilised.212 The OMT programme was only announced, never actually implemented because the necessary legal acts to establish the OMT programme were never adopted.213 Nevertheless, just the announcement of the OMT programme and its features was sufficient to affect the yields on the sovereign bonds of euro countries, meaning that the spreads of yields on these bonds got significantly smaller.214

Expanded asset purchase programme is a collective name for purchase programmes within which the ECB is purchasing both private and public sector securities. 215 The objective of these programmes is fulfilling the objective of monetary policy i.e. to fight the prolonged period of low inflation and fulfil price stability mandate. 216 There are currently following purchase programmes: Corporate sector purchase programme (CSPP), Public sector purchase programme (PSPP), Asset-backed securities purchase programme (ABSPP), Third covered bond purchase programme (CBPP3).

210 Technical features of Outright Monetary Transactions [press release]. European Central Bank [online]. European Central Bank published 6 September 2012 [cit. 2018-08-04]. 211 HERRMANN C., CORINNA D. International and European Monetary Law: An Introduction. Cham: Springer, 2017. SpringerBriefs in Law. p. 133. 212 Technical features of Outright Monetary Transactions [press release]. European Central Bank [online]. European Central Bank published 6 September 2012 [cit. 2018-08-04]. 213 HERRMANN C., CORINNA D. International and European Monetary Law: An Introduction. Cham: Springer, 2017. SpringerBriefs in Law. p. 133. 214 BREUSS F. The crisis management of the ECB. In: DA COSTA CABRAL N., GONCALVES J., CUNHA RODRIQUEZ, N. (Eds.) The Euro and the crisis. Perspectives for the Eurozone as a Mone- tary and Budgetary Union. Springer International Publishing, 2017. Financial and Monetary Policy Studies, vol. 43. p.202. ISBN: 978-3-319-45710-9. 215 Asset purchase programmes. European Central Bank [online]. European Central Bank, copyright 2018 [cit. 2018-08-04]. 216 Ibid. 55

The PSPP, the programme with purchases of biggest volume from the mentioned programmes was introduced on 4 March 2015 by a decision of the Governing Council of the ECB217. Reason for its introduction was that the at that time already existing purchase programmes focused on private sector assets, the ABSPP and the CBPP3, were insufficient to achieve the target inflation. 218 The decision of the ECB introducing the PSPP contains conditions for its implementation, safeguards, and declarations such as that the PSPP fully complies with the obligations of the Eurosystem and prohibition of monetary financing.219 With the introduction of the PSPP we can speak about quantitative easing aimed at expanding the money base.220 The announced monthly maximum volume of purchases within the expanded asset purchase programme since March 2015 was set on 60 billion euro221, the volume of purchases within the PSPP being biggest in volume since the effective start of the purchases on 9 March 2015222, as is demonstrated in fig. no 1. Volume of purchases per month remained on €60 billion until March 2016, then from April 2016 until March 2017 the volume was raised to €80 billion per month, from April 2017 to December 2017 the volume was reduced again to €60 billion per month, from January 2018 until September 2018 the volume was reduced to half i.e. 30 billion per month.’223 Since October 2018 purchases under expanded asset purchase programme were reduced to 15 billion euro per month until December 2018. Depending on the outlook of medium-term inflation the ECB expects for the net purchases to end then.224 Whereas the interest rates levels remained since 16th March 2016 until now (October

217 Decision of the European Central Bank ECB/2015/10 of 4 March 2015 on a secondary markets public sector asset purchase programme. 218 Recital (4) of the Decision of the European Central Bank ECB/2015/10 of 4 March 2015 on a secondary markets public sector asset purchase programme. 219 Recital (5) of the Decision of the European Central Bank ECB/2015/10 of 4 March 2015 on a secondary markets public sector asset purchase programme. 220 DE GRAUWE P. Economics of Monetary Union.11th ed. Oxford: Oxford University Press, 2016, p. 208. 221 Ibid. 222 Article 10 of the Decision of the European Central Bank ECB/2015/10 of 4 March 2015 on a secondary markets public sector asset purchase programme. 223 Asset purchase programmes. European Central Bank [online]. European Central Bank, …. [cit. 2018- 08-04]. 224 Monetary policy decisions [press release]. European Central Bank [online]. European Central Bank published 13 September 2018 [cit. 2018-10-08]. 56

2018) on following levels: deposit facility – 0.40 %, main refinancing operations 0.00 %, marginal lending facility 0.25 %, all the interest rate levels are per annum.225 And according to the latest decision of Governing Council of the ECB on 13 September, 2018 will remain so through the summer of 2019.226

Fig. no. 1

6.3 Legal assessment

As mentioned in previous chapter, set of monetary policy instruments available to the ECB and relevant national central banks provided for in Articles 17 to 19 of the ESCB Statute do not form an exhaustive list and the Governing Council of the ECB may under conditions of Article 20 of the ESCB Statute decide upon use of any monetary policy instruments it sees fit. Article 20 of the ESCB Statute thus provides for legal basis for adopting the non-standard monetary policy measures by the Governing Council of the

225 Key ECB interest rates. European Central Bank [online]. European Central Bank, copyright 2018 [cit. 2018-10-08]. 226 Monetary policy decisions [press release]. European Central Bank [online]. European Central Bank published 13 September 2018 [cit. 2018-10-08]. 57

ECB under the conditions set out in Article 20 of the ESCB Statute, i.e. the Governing Council must act by a majority of two thirds of votes cast and the measure must respect Article 2 of the ESCB Statute.

With all monetary policy decisions, the ECB must observe the rules of the EU law whereby the acts and omissions of the ECB fall under the review of the Court of Justice of the EU (CJEU) in cases and under conditions laid down by the TFEU.227 In connection with the non-standard measures of the ECB’s monetary policy, the purchases (or in case of the OMT programme announced purchases) of sovereign bonds by the ECB were those that caused controversy and were subject to review by the CJEU. The issue was whether the ECB circumvented its exclusive powers granted only for the area of monetary policy and the prohibition of monetary financing enshrined in Article 123 of the TFEU. There have been cases considered by the CJEU concerning the non-standard monetary policy measures of the ECB within the action for annulment procedure before the General Court228, within the action for damages caused by the ECB under Article 268 of the TFEU in connection with Article 340 of the TFEU229, in one case within the preliminary procedure before the European Court of Justice230, and one case is yet to be decided within the preliminary procedure which was referred to the ECJ in July 2017231, however to date (October 2018) it has not been decided yet. In none of the cases decided up until today any of the non-standard monetary policy measures of the ECB was found breaching the claimed Articles of the Treaties.

227 Article 35 of the ESCB Statute. 228 Order of the General Court of 10 December 2013, Von Storch and Others v ECB, Case T-492/12; Or- der of the General Court of 25 June 2014 – Accorinti and Others v ECB, Case T-224/12. 229 Judgement of the General Court (fourth chamber) of 7 October 2015, Accorinti and Others v ECB, Case T-79/13. 230 Judgement of the Court (Grand Chamber) of 16 June 2015, Gauweiler, Case C-62/14. 231 Proceedings on the European Central Bank’s expanded asset purchase programme are stayed - Referral to the Court of Justice of the European Union [Press release]. Bundesvervassungsgericht [online]. Bundesvervassungsgericht, 15 August 2017. [cit. 2018-10-14]. 58

7 Author’s findings: comparison of unconventional monetary policy of the CNB and the ECB

In this chapter the findings on unconventional monetary policy of the CNB and the ECB based on the analysis in the thesis are compared according to set of 6 criteria regarding the economical and legal aspects. The criteria for comparison chosen concerning the economic aspects are: (1) aim pursued by the implemented unconventional monetary policy instrument, (2) the chosen instrument, and (3) outcome of the unconventional monetary policy. The Criteria concerning the legal aspects are (4) power of the central banks to defined and conduct (un)conventional monetary policy, (5) the character of monetary policy decision, and (6) judicial review of a monetary policy decision of the central banks.

7.1 Aim pursued

In general

The CNB and the ECB pursue the same main objective which is maintaining price stability, imposed on the CNB by Article 98(1) of the Constitution of the Czech Republic and by Article 2(1) of the Act on the CNB, and on the ECB by Articles 119(2), 127(1), 282(2) of the TFEU and by Article 2 of the ESCB Statute.

Next to the main objective of maintaining price stability, and without prejudice to it, both the CNB and the ECB shall support general economic policies in case of the CNB the general economic policies of the government of the Czech Republic leading to sustainable economic growth and the general economic policies in the European Union with a view to contributing to the achievement of the objectives of the European Union acting in 59 accordance with the principle of an open market economy232, in case of the ECB the general economic policies in the European union shall be supported, in accordance with the principle of an open market economy with free competition, and with a view to contributing to the achievement of the objectives of the EU233. In case of the ECB the TFEU provides in addition that guiding principles with which the monetary policy must be in compliance are stable prices, sound public finances and monetary conditions and sustainable balance of payments.234

The similarity between the objectives of monetary policy of the central banks and their formulation is firstly due to the fact, as observed in chapter 1 of the thesis, that currently such goal is pursued by many central banks in the world, mostly those of the developed countries235, secondly, due to the fact that the Czech Republic had to as a member state of the EU make its national legislation compatible with the Treaties and the Statute of the ESCB and of the ECB, as provides Article 131 of the TFEU. Thus, the objective of Czech National Bank to ‘ensure stability of the Czech currency’ was replaced by objective to ’maintain price stability’.236

The objective is in both cases quantified using a set inflation target which is defined by increase of consumer prices using a consumer price index. In both cases the central banks themselves have the power to define it. As for the CNB, the objective of the monetary policy is quantified in form of inflation measured using consumer price index. Since 2010, the inflation target announced and pursued by the CNB is 2%, with possible derogation limited on 1% each way. As for the ECB, the primary objective of price stability is quantified as inflation rate below, but close to, 2% over the medium term, where inflation is defined as a year-on-year increase in consumer prices measured by the Harmonised Index of Consumer Prices, which is an index harmonized across euro area

232 Articles 119(2), 127(1), 282(2) of the TFEU, Article 2 of the ESCB Statute. 233 Article 119(2) 127(1), 282(2) of the TFEU, Article 2 of the ESCB Statute. 234 Article 119(4) of the TFEU. 235 At present 66 central banks of the world (including the ECB) are targeting inflation to achieve the goal of price stability. Source: Inflation Targets. Central Bank News [online]. Central Bank News, © 2012. [cit. 2018-10-15]. 236 RÝDL T. et al. Zákon o České národní bance komentář. Prague: Wolters Kluwer a.s., 2014, p. 15. 60 member states.237 It has been defined in this manner by the ECB since its establishment in 1998.238

Aim of the unconventional monetary policy

With their unconventional monetary policy both banks pursued the objectives as described above. When faced with the situation where the conventional monetary policy was not effective anymore due to the economic situation brought about by the economic and financial crisis starting in 2008 and later the sovereign debt crisis in the Eurozone, in other words under those cisrcumstances it was not possible for either of the central banks to achieve the objective of price stability using the conventional monetary policy instruments, both of the banks had to start with unvonventional monetary policy to achieve the objective of price stability defined above.

7.2 Chosen instruments

As described above, motivation for implementation of unconventional monetary policy was the same for both the CNB and the ECB. That is that due to the crisis since 2008 the conventional monetary policy turned out to be insufficient to fulfil the monetary policy objective of price stability. However, choice of the unconventional monetary policy instruments was different.

The CNB, after reducing interest rates to technical zero i.e. 0.05% 2W repo rate, 0.05% discount rate, 0.25% Lombard rate in November 2012239, implemented in November 2013 the unconventional monetary policy instrument – foreign exchange interventions carried out in unlimited volume and time to keep the exchange of the Czech koruna at 27 CZK/EUR. As observed in chapter 3, the CNB chose to apply this instrument taking in regard the openness of the Czech economy, good knowledge of the functioning of

237 ECB. The Monetary Policy of the ECB. Frankfurt am Main: European Central Bank, 2011, p.9. 238 Ibid. 239 Měnověpolitické nástroje ČNB – změny v roce 2012. Česká národní banka [online]. Czech National Bank, ©2003-2018 [cit. 2018-10-02]. 61 exchange rate transmission channel, long term excess of liquidity in the banking sector, and relatively shallow markets with debt instruments.240 The rationale behind application of this instrument was that weaker currency reflects in increase of import prices which cause increase of overall inflation, and subsequently inflationary pressures from domestic economy are faster restored241, in other words the function of this monetary policy instrument was to faster achieve the monetary policy objective, inflation at 2% and leave the zero lower bound of the CNB’s interest rates.

Unlike from the CNB the ECB implemented broader range of unconventional monetary policy instruments, in terminology of the ECB non-standard monetary policy measures. Not only had the ECB deal with its monetary policy being ineffective due to rates reduced substantially, and eventually to zero, and paralysed interbank money markets due to the 2008 financial and economic crisis, the ECB was in more difficult position than other central banks because sovereign debt crisis affected the eurozone242, and so the ECB also had to address tensions in the sovereign bonds markets

The ECB reduced its key interest rates since the October 2008 from deposit lending facility on 3.25, main refinancing rate at 3.75, and marginal lending facility at 4.25 over the years down to deposit facility at -0.40, main refinancing rate at 0.00, and marginal lending facility at 0.25.243 To deal with the problem of paralysed interbank money markets, whose proper functioning is essential for ECB’s monetary policy to have the desired effect, the ECB embarked on set of non-standard measures later referred to collectively as enhanced credit support. 244 To address tensions in the public and private

240 FRANTA M. et al. Měnový kurz jako nástroj při nulových úrokových sazbách: případ ČR. Research and Policy notes 3/2014. Prague: Czech National Bank, 2014, p. 4. 241 Zpráva o inflaci IV/2013. Czech National Bank [online]. Prague: Czech National Bank, 2013, 86 p. [cit. 2018-08-10]. p.8. 242 DĚDĚK O. Doba Eura: Úspěchy i nezdary společné evropské měny. 1st ed. Prague: Linde Praha a.s., 2014, p. 260. 243 Key ECB interest rates. European Central Bank [online]. European Central Bank, copyright 2018 [cit. 2018-10-08]. 244 STARK J. Monetary Policy before, during and after the financial crisis [speech at University Tü- bingen, Tübingen, 9 November 2009]. Europan Central Bank [online]. European Cental Bank, copyright 2018. [cit. 2018-08-02]. 62 debt securities markets the ECB introduced on 14 May 2010245 the Securities Markets Programme (SMP) with the objective to ensure depth and liquidity in dysfunctional segments of the markets and restore appropriate monetary policy transmission mechanism.246 The SMP was terminated by announcement of technical features of Outright monetary Transactions (OMTs) programme on 12 September 2012.247The ECB also carries out Expanded asset purchase programme which is a collective name for purchase programmes within which the ECB is purchasing both private and public sector securities. 248 The objective of these programmes is fulfilling the objective of monetary policy i.e. to fight the prolonged period of low inflation and fulfil price stability mandate. 249

7.3 Outcome of the unconventional monetary policy

Whereas the use of monetary policy instrument by the CNB has been terminated, the ECB is still conducting its unconventional monetary policy, however there are indications that it will stop with the purchases under the Asset purchase programme soon.

The CNB conducted the foreign exchange interventions from 7 November 2013 until 6 April 2017. The use of the unconventional monetary policy instrument was terminated on 6 April 2017 because at that point sustainable fulfilment of 2 % inflation target250 in future could be determined. Thus, the CNB could return to use of conventional monetary policy instruments, and later it started to gradually increase its interest rates which are today (October 2018) at levels: discont rate 0.5 %, 2 week repo rate 1.5%, Lombard rate

245 Decision of the European Central Bank ECB/2010/5 of 14 May 2010 establishing a securities markets programme. 246 ECB decides on measures to address severe tensions in financial markets [press release]. European Central Bank [online]. European Central Bank, published 10 May 2010 [cit. 2018-08-04]. 247Technical features of Outright Monetary Transactions [press release]. European Central Bank [online]. European Central Bank published 6 September 2012 [cit. 2018-08-04]. 248 Asset purchase programmes. European Central Bank [online]. European Central Bank, copyright 2018 [cit. 2018-10-08]. 249 Ibid. 250 Minutes of the extraordinary monetary policy meeting of the Bank Board on 6 April 2017. Česká národní banka [online]. Czech National Bank, ©2003-2018 [cit. 2018-10-17]. 63

2.5%.251 Final volume of the foreign exchange interventions was 2050 billion of Czech Koruna252, the CNB’s foreign exchange reserves thus increased from 22% to 67% in relation to the GDP253 since the start of the foreign exchange interventions in 2013.

The ECB is still conducting its quantitative easing, purchases under its Asset purchase programme, however in smaller volume than in the beginning in March 2015. The volume of purchases per month was 60 billion euros from March 2015 until March 2016, 80 billion euros from April 2016 until March 2017, 60 billion euros from April 2017 until December 2017, 30 billion euros from January 2018 until September 2018254. Since October 2018 purchases under expanded asset purchase programme were reduced to 15 billion euro per month until December 2018. Depending on the outlook of medium-term inflation the ECB expects for the net purchases to end then255 and the ECB would return to use of conventional monetary policy instruments only. The interest rates levels remained since 16th March 2016 until now (October 2018) on following levels: deposit facility – 0.40 %, main refinancing operations 0.00 %, marginal lending facility 0.25 %, all the interest rate levels are per annum.256 And according to the latest decision of Governing Council of the ECB on 13 September 2018 will remain so through the summer of 2019.257 Current holdings of the Eurosystem under the Asset purchase programme were determined at 2,532,098 million of euros at the end of September 2018.258

251 Měnověpolitické nástroje ČNB – změny v roce 2018. Česká národní banka [online]. Czech National Bank, ©2003-2018 [cit. 2018-10-02]. 252 ALIAPULIOS J. Známe konečný účet za intervence. Na umělé oslabení koruny dala ČNB přes dva biliony. Aktuálně.cz [online]. Economia, published on 7 June 2017 [cit. 2018-08-13]. 253 MORA M., KRÁL P. Měnová politika má vždy přednost před dopady do hospodaření ČNB. Česká národní banka [online]. Czech National Bank, ©2003-2018 [cit. 2018-07-12] 254 Asset purchase programmes. European Central Bank [online]. European Central Bank, copyright 2018 [cit. 2018-10-08]. 255 Monetary policy decisions [press release]. European Central Bank [online]. European Central Bank published 13 September 2018 [cit. 2018-10-08]. 256 Key ECB interest rates. European Central Bank [online]. European Central Bank, copyright 2018 [cit. 2018-10-08]. 257 Monetary policy decisions [press release]. European Central Bank [online]. European Central Bank published 13 September 2018 [cit. 2018-10-08]. 258 Asset purchase programmes. European Central Bank [online]. European Central Bank, copyright 2018 [cit. 2018-10-08]. 64

7.4 Power to define and conduct (un)conventional monetary policy

The difference between the source of the powers and legal regulation of the power of the CNB and the ECB to formulate and conduct monetary policy, irrespectively of whether it is conventional or unconventional, is based on the fact that the CNB is a central bank of a state with competence for its monetary policy whereas the ECB is a body of the European Union and a central bank with monetary policy competence for more countries having a single currency. Thus, whereas the CNB based on the Constitution of the Czech Republic and the Act on the CNB has both formulates and conducts monetary policy, the ECB has exclusive competence for monetary policy within the scope of powers conferred upon it by the member states who adopted Euro, it formulates the monetary policy and conducts it through national central banks of the Eurosystem.

Power to define and conduct (un)conventional monetary policy is given to the CNB primarily by the Constitution of the Czech Republic which in Article 98(1) provides that the CNB’s main objective is to maintain price stability and at the same time provides basis for its independence by stating that with its functioning it can be interfered with on basis of a statute. As the Constitution of the Czech Republic foresees in Article 98(2) the CNB is further regulated by the Act on the CNB, which provides in Article 2 that the main objective of the CNB is to maintain price stability. To that end it imposes the task to define monetary policy on the CNB by Article 2(2), and it is namely the Bank Board of the CNB which is obliged by Article 5(1) of the Act on the CNB to set monetary policy and monetary policy instruments to implement it and decide on fundamental monetary policy measures. Neither the Constitution of the Czech Republic, nor the Act on the CNB recognizes a difference between conventional and unconventional monetary policy or monetary policy instruments. Therefore, it is within the power of the Bank Board of the CNB to decide which monetary policy instrument to implement and how, provided of course that it is in accordance with its primary objective and it does not violate the law.

Member states of the EU who have adopted the euro conferred powers regarding monetary policy onto the ECB which holds in the scope of the conferred powers exclusive 65 competence for monetary policy for the Euro area as provided by Article 3(1)c of the TFEU. That means that in accordance with Article 2(1) of the TFEU in the area of monetary policy for the Euro area only relevant bodies of the EU may adopt legally binding acts whereas the member states can only do so if they are empowered by the EU or they do so in order for implementing an act of the EU in that area. In line with the provision of Article 2(1) of the TFEU the Article 12(1) ESCB Statute provides, that it is the Governing Council of the ECB which formulates the monetary policy and the Executive board of the ECB which implements it by providing necessary instructions to the national central banks of the Eurosystem which carry it out. Monetary policy of the Euro area is thus implemented through decentralised system where the ECB acts as a central governing body and coordinates the operation and the NCBs operate as executive branches, carrying out the transactions.259 But it must be pointed out that each of the Euro area member states participate on the decision making and formulation of the MP through the governor of its central bank who is a member of the Governing Council. Like the regulation of monetary policy of the CNB, neither the TFEU nor the ESCB Statute differentiates between power to formulate and conduct conventional and unconventional monetary policy. Formulation of Governing Council’s power to formulate monetary policy in Article 12(1) of the ESCB Statute, which reads: ‘The Governing Council shall formulate the monetary policy of the Community including, as appropriate, decisions relating to intermediate monetary objectives, key interest rates and the supply of reserves in the ESCB, and shall establish the necessary guidelines for their implementation.’, clearly does not provide limited list of steps the Governing Council may take and thus enables the Governing Council to set unconventional monetary policy instruments.

7.5 Character of monetary policy decisions

Monetary policy of both the CNB and the ECB is formulated through monetary policy decisions adopted by their relevant decision-making bodies. In both cases the decision- making bodies are independent and enjoy discretion on what monetary policy instrument to implement and thus enabling implementation of unconventional monetary policy instruments described in chapters 4 and 6.

Within the competence of the CNB to formulate monetary policy according to Article 2(2)a of the Act on the CNB and to fulfil the main objective of maintaining price stability the Bank Board of the CNB adopts decisions on monetary policy measures and instruments according to Article 5(1) of the Act on the CNB. These decisions are adopted by the 7 members of the Bank Board of the CNB based on rules contained in Article 7(1) of the Act on the CNB, which provides that the Bank Board of the CNB acts on simple majority of votes cast where at least the governor or a vice-governor nominated by him and three other members of the Bank Board must be present. The unconventional monetary policy instrument, foreign exchange interventions conducted by the CNB to keep the exchange rate of the Czech Koruna on the level 27CZK/EUR was implemented by virtue of decision of the Bank Board of the CNB of 7 November 2013.

As observed in previous subchapter the Bank Board of the CNB has power to set monetary policy and instruments for its implementation pursuant to Article 5(1) of the Act on CNB, whereas the instruments are not limited anywhere in the text of the Act on the CNB. Article 23 of the Act on the CNB merely provides that: ‘The Czech National Bank shall set the interest rates, structures, maturities and other terms and conditions for the transactions it performs pursuant to this Act and other legislative acts.‘ Moreover, Article 35(a) of the Act on the CNB provides that the CNB shall manage foreign exchange reserves, and Article 36 of the Act on the CNB provides that the CNB has the power to trade foreign exchange and carry out all types of banking transactions in the financial market. Thus, based on Articles 5(1) of the Act on the CNB read in conjunction with Article 35, and 36 of the Act on the CNB the Bank Board of the CNB acted within the 67 scope of the Act on the CNB when implementing foreign exchange interventions as monetary policy instrument.

As a decision-making body of the ECB, the Governing Council is a governing body of the ESCB and thus it ensures in accordance with Article 9.2 of the ESCB Statute that tasks conferred upon the ESCB under Article 127(2), (3) and (5) of the TFEU are implemented. It is the Governing Council which formulates the monetary policy of the Eurosystem as provided by Article 12(1) of the ESCB Statute ‚including, as appropriate, decisions relating to intermediate monetary objectives, key interest rates and the supply of reserves in the ESCB,and shall establish the necessary guidelines for their implementation’.260Based on Article 20 of the ESCB Statute the Governing Council may by a majority of two third of the votes cast decide upon such operational methods of monetary control as it sees fit while respecting Article 2 of the ESCB Statute providing for objectives of the ESCB. That means that the Governing Council is not limited only to monetary policy instruments provided for in Articles 17 to 19 of the ESCB Statute. Since the number of the Governing Council members have exceeded 21, only 15 governors of Eurosystem national central banks vote at a time when adopting decision where the voting rights always rotate and are assigned according to rules of Article 10.2 of the ESCB Statute.

Since the Article 20 of the ESCB Statute does not provide for exhaustive list of instruments the Governing Council may implement by its decision, it enabled adoption of non-standard monetary policy measures described in chapter 6, i.e. the Enhanced Credit Support, the Securities Market Programme, Outright Monetary Transactions, and Enhanced Asset purchase programme.

7.6 Judicial review

Judicial review of the CNB’s monetary policy decisions is not provided expressly anywhere in the legal documents regulating it, on the contrary the Statute on the ESCB

260 Article 12(1) of the ESCB Statute. 68 provides expressly on judicial review of acts of the ECB including monetary policy decisions. At the same time whereas there were no proceedings concerning the unconventional monetary policy instrument of the CNB (or any other monetary policy decision of the CNB), there have been proceeding before the European Court of Justice concerning some of the non-standard measures of the ECB.

Neither the Constitution of the Czech Republic nor the Act on the CNB expressly provide whether and eventually how are monetary policy decisions of the Bank Board of the CNB, i.e. the decisions of the Bank Board of the CNB it adopts within its competence as a monetary policy authority subject to judicial review. Commentaries on the Act on the CNB are also silent on this issue. In this regard decisions of the Bank Board of the CNB it adopts within its competence to formulate monetary policy to fulfil the objective of price stability must be strictly distinguished from other decisions of the Bank Board of the CNB it adopts within its competence as administrative authority according to Article 1(3) of the Act on the CNB. The latter are as decisions adopted by the CNB within administrative procedures the CNB conducts according to the Act on CNB, e.g. in the sphere of supervision over financial market261, subject to review by relevant administrative courts. It is true that regarding the competence of the CNB to formulate and conduct monetary policy to fulfil the objective of maintaining price stability the CNB enjoys broad independence, demonstrated by the fact that the objective of maintaining price stability is enshrined in Article 98(1) of the Constitution of the Czech Republic, and discretion demonstrated by the fact that it is up to the CNB to define what is price stability since both the Article 98(1) of the Constitution of the Czech Republic and Article 2(1) of the Act on the CNB mention only that the objective is to maintain price stability. However, despite the broad independence and discretion regarding monetary policy, there is no provision stating that monetary policy decisions are not subject to judicial review. Hypothetically it is possible that a monetary policy decision would be in breach of some provisions of the Act on the CNB for example provisions on independence of the CNB, or in breach of the Article 98(1) of the Constitution of the Czech Republic. The latter,

261 RÝDL T. et al. Zákon o České národní bance komentář. Prague: Wolters Kluwer a.s., 2014, p 7. 69 even though not mentioning expressly independence of the CNB in connection to the objective of maintaining price stability must be in accordance with the judgement of the Constitutional Court of the Czech Republic of 20 June 2001, Pl. ÚS 59/2000, interpreted as establishing the CNB’s independence on constitutional level.262 Therefore action for annulment of a monetary policy decision for conflict with constitutional order or a statute according to Article 87(1)b of the Constitution of the Czech Republic might be possible, however it is uncertain because such situation has never occurred in past and moreover, it is doubtful whether monetary policy decision of the Bank Board of the CNB has a form of ‘other legal enactment’ in the sense of Article 87(1)b of the Constitution of the Czech Republic.

Up until today (October 2018) there have been no publicly known judicial procedures before the Czech Courts concerning monetary policy decisions including any monetary policy decision of the Bank Board of the CNB concerning the unconventional monetary policy instrument, the foreign exchange interventions conducted between November 2013 and April 2017.

Article 35 of the ESCB Statute expressly provides that acts and omissions of the ECB fall under the review of the Court of Justice of the EU (CJEU) in cases and under conditions laid down by the TFEU.263 Thus, in general monetary policy decisions of the Governing Council of the ECB might be disputed before the CJEU within the preliminary procedure under Article 267 of the TFEU, within the annulment procedure under the Article 263 of the TFEU, or under the procedure for damages under Article 268 TFEU.

So far, monetary policy decisions of the Governing Council of the ECB, namely those connected to use of unconventional monetary policy instruments of the ECB were subject of two cases within the action for annulment procedure before the General Court, in one case under the procedure for damages before General Court, in one case within the preliminary procedure before the European Court of Justice, and one case where a the

262 Judgement of the Constitutional Court of the Czech Republic of 20 June 2001, Pl. ÚS 59/2000. 263 Article 35 of the ESCB Statute. 70

German Constitutional court referred to the ECJ to answer a question is to be decided by the European Court of Justice, however to date (October 2018) it has not been decided yet.

The two cases concerning action for annulment of ECB’s monetary decisions were case T-492/12 von Storch and others and case T-224/12 Accorinti and others. In case T-492/12 von Storch and others individual applicants sought annulment of the decision of the Governing Council of the ECB of 6 September 2012 technical features of the OMT programme under Article 263 of the TFEU before the General Court for incompatibility with Articles 123 to 125 TFEU264, however the General Court dismissed the action as inadmissible265 without examining the merits of the action. In case T-224/12 Accorinti and others v ECB claimants pursued within the action for annulment procedure according to Article 263 TFEU annulment of decision of the ECB 2012/153/EU of 5 March 2012 on 'the eligibility of market debt instruments issued or fully guaranteed by the Hellenic Republic in the context of the Hellenic Republic's debt exchange offer‘ for inter alia breach of Article 123 of the TFEU.266 The action was dismissed as inadmissible by the General Court. 267 In case T-79/13 Accorinti and Others v ECB claimants sought that the General Court would find the ECB liable for damages caused to claimants pursuant to Article 340 of the TFEU by actions connected to decision of the ECB 2012/153/EU of 5 March 2012.268 The General Court reviewed the action on mertis, however, it dismissed it as unjustified.269

The decision of the Governing Council on technical features of the OMT programme of 6 September of 2012 was considered by the ECJ in case C-62/14 within the preliminary procedure under Article 267 of the TFEU. The ECJ had to answer a question referred to

264 Action brought on 12 November 2012, von Stroch and Others v ECB, Case T-492/12. 265 Order of the General Court of 10 December 2013, Von Storch and Others v ECB, Case T-492/12. 266 Action brought on 23 May 2012 Accorinti and others v ECB, Case T-224/12. 267 Order of the General Court of 25 June 2014 – Accorinti and Others v ECB, Case T-224/12. 268 Action brought on 11 February 2013 Accorinti and Others v ECB, Case T-79/13. 269 Judgement of the General Court (fourth chamber) of 7 October 2015, Accorinti and Others v ECB, Case T-79/13. 71 it by the German Constitutional Court, and had to determine validity of the afore mention decision of the Governing Council of the ECB and had to interpret Articles 119 TFEU, 123 TFEU and 127 TFEU and of Articles 17 to 24 of the ESCB Statute.270 In this decision the ECJ found that the OMT programme falls within the monetary policy and thus within the exclusive power of the ECB271, it found that the announced OMT programme and subsequent approval of its main parameters on 5 and 6 September 2012 did not breached the prohibition of monetary financing set out in Article 123 of the TFEU.272 But the Court mentioned limits that the purchases of sovereign bonds on the secondary markets have in order to not breach the monetary financing ban in art. 123 TFEU. The potential purchasers of the government bonds on the primary market must not know for certain that the ESCB will purchase those bonds within certain period because under such conditions those market operators would act, de facto, as intermediaries for the ESCB for the direct purchase of those bonds from the public authorities and bodies of the Member State concerned273, moreover purchases of government bonds are possible only in so far as is necessary for safeguarding the monetary policy transmission mechanism and the singleness of monetary policy and that those purchases will cease as soon as those objectives are achieved.274

The decision of Governing Council of 4 March 2015 on secondary markets public sector purchase programme is currently subject to preliminary ruling by the ECJ under Article 267 of the TFEU. By an order of 18 July 2017 the German Constitutional Court stayed proceedings lead before it in case of a constitutional complaint and referred several questions to the ECJ.275 Regarding inter alia the compliance of the Public sector purchase programme as it was implemented with the prohibition in art. 123 TFEU, namely that the

270 Gauweiler para. 1. 271 Gauweiler para. 46. 272 Gauweiler para. 127. 273 Gauweiler para. 104. 274 Gauweiler para. 112. 275 Proceedings on the European Central Bank’s expanded asset purchase programme are stayed - Referral to the Court of Justice of the European Union [Press release]. Bundesvervassungsgericht [online]. Bundesvervassungsgericht, 15 August 2017. [cit. 2018-10-14]. 72 conditions set out by the CJEU in case Gauweiler which any ECB purchase programme must fulfil in order not to circumvent the objective of Article 123 TFEU, are not fulfilled by the PSPP and therefore it breaches the Article 123 TFEU and regarding the mandate of ECB to adopt the PSPP decision, in other words whether the purchases under the PSPP fall within the monetary policy of the ECB or the economic policy276. Up to date (October 2018) the ECJ has not rendered a decision yet and it is not certain whether it will do so in time before the purchases within the PSPP stop.

276 Proceedings on the European Central Bank’s expanded asset purchase programme are stayed - Referral to the Court of Justice of the European Union [Press release]. Bundesvervassungsgericht [online]. Bundesvervassungsgericht, 15 August 2017. [cit. 2018-10-14]. 73

Conclusion

This thesis concerned monetary policy of the Czech National Bank and the European Central bank with the particular aim to examine the unconventional instruments of monetary policy used by the CNB and the ECB in greater detail and compare them, focusing mainly on the legal aspects.

Before the monetary policy of each of the central banks was examined monetary policy in general, its regulation by the law, and aspects connected to conduct of the monetary policy by a central bank – independence of a central bank and accountability for its monetary policy were described. To clarify the relation between the two central banks and their monetary policies, the European System of Central banks and the position of the ECB and the CNB within the system were examined. Analyzing texts of legal regulation, court judgements, information provided by each of the central banks on their websites, and relying on monographs and articles of scholars, firstly, the monetary policy of the CNB was examined, i.e. its objective, instruments, and independence and accountability for monetary policy were described, whereas the unconventional monetary policy instrument, the foreign exchange interventions were examined in greater detail, and secondly, the monetary policy of the ECB was examined, i.e. its objective, instruments, and independence and accountability for monetary policy were described, whereas the non-standard measures of ECB’s monetary policy were examined in greater detail.

Similarities and differences between the (un)conventional monetary policies of the CNB and the ECB were clearly identified using the comparison method and considering the findings on (un)conventional monetary policies of the two central banks next to each other based on 6 determined criteria, which were: (1) aim pursued by the implemented unconventional monetary policy instrument, (2) the chosen instrument, and (3) outcome of the unconventional monetary policy, (4) power of the central banks to defined and conduct (un)conventional monetary policy, (5) the character of monetary policy decision, and (6) judicial review of a monetary policy decision of the central banks.

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