ANALYSES OF THE CZECH REPUBLIC’S CURRENT ECONOMIC ALIGNMENT WITH THE EURO AREA 7 1 0 2 1 Authors: Kateřina Arnoštová A, B Tomáš Adam C, Box 1 Oxana Babecká Kucharčuková 1.1.3, 1.1.4, Box 3 Jan Babecký 1.2.5, Box 5 Vojtěch Belling D Soňa Benecká 1.1.4 Jan Brůha F, Box 2 Martin Gürtler 2.3.1 Tibor Hlédik Box 4 Tomáš Holub A, B, 1.1.1 Eva Hromádková 1.1.2, 2.1.3 Luboš Komárek C, 1.2.5 Zlatuše Komárková 1.2.5 Petr Král A, B Ivana Kubicová 1.2.2, 1.2.3 Filip Novotný 1.1.5 Barbora Malá D Lucie Matějková A, B Renata Pašaličová 1.2.6 Lukáš Pfeifer 1.2.1, 2.4 Luboš Růžička 2.2.1, 2.2.3 Branislav Saxa 1.2.4 Vojtěch Siuda 1.2.1, 2.4 Pavel Soukup 2.1.1, 2.1.2, 2.1.3 Radek Šnobl 2.2.1, 2.2.2, Box 4 Jan Šolc Box 4 Jan Vlček Box 4 Martin Vojta D Mário Vozár 2.2.3 Editors: Lucie Matějková Kateřina Arnoštová Czech National Bank / Analyses of the Czech Republic’s economic alignment with the euro area 2017 CONTENTS 2 A INTRODUCTION ................................................................................................... 5 B SUMMARY ............................................................................................................ 6 C ECONOMIC ALIGNMENT OF EURO AREA COUNTRIES .......................................... 12 Box 1: Cohesion of euro area countries from the perspective of the indicators used in the Macroeconomic Imbalance Procedure ...................................................................... 17 D ECONOMIC POLICY AND INSTITUTIONAL DEVELOPMENTS IN THE EUROPEAN UNION AND THE EURO AREA ............................................................................. 19 E RESULTS OF THE ANALYSES FOR THE CZECH REPUBLIC .................................... 23 1 CYCLICAL AND STRUCTURAL ALIGNMENT ......................................................... 23 1.1 Direct alignment indicators ............................................................................... 23 1.1.1 Real economic convergence ......................................................................... 23 Box 2: The real exchange rate and productivity before and after the recession ............. 26 1.1.2 Correlation of economic activity ................................................................... 28 1.1.3 Structural similarity of the economies ........................................................... 32 1.1.4 Interest rate convergence, analysis of exchange rate volatility and exchange rate alignment ............................................................................................................ 33 Box 3: Correlation between the koruna-dollar and euro-dollar exchange rates before and after the exchange rate commitment ....................................................................... 36 1.1.5 Integration of the economy with the euro area .............................................. 37 1.2 Similarity of monetary policy transmission ......................................................... 40 1.2.1 Financial system ........................................................................................ 41 1.2.2 Structure of financial assets and liabilities of corporations and households ........ 42 1.2.3 Effect of monetary policy on client interest rates ............................................ 45 1.2.4 Inflation persistence ................................................................................... 50 1.2.5 Financial market alignment ......................................................................... 51 1.2.6 Spontaneous euroisation ............................................................................. 52 2 ADJUSTMENT MECHANISMS .............................................................................. 57 2.1 Fiscal policy .................................................................................................... 57 2.1.1 Stabilising function of public budgets ............................................................ 57 2.1.2 Government deficit and debt and the scope for stabilising fiscal policy .............. 59 2.1.3 Government finance sustainability ................................................................ 62 2.2 Labour market flexibility .................................................................................. 64 2.2.1 Unemployment and internal labour market flexibility ...................................... 64 Box 4: Estimate of structural unemployment using the NAIRU and correlation of the cyclical component of unemployment ...................................................................... 68 2.2.2 International labour mobility ....................................................................... 70 2.2.3 Institutional environment of the labour market .............................................. 71 Box 5: Wage rigidity and the use of flexible wage components in 2010–2013: European firm-level survey evidence ..................................................................................... 75 2.3 Product market flexibility ................................................................................. 76 2.3.1 Administrative barriers to entrepreneurship ................................................... 76 2.4 The banking sector and its shock-absorbing capacity ........................................... 79 F THEORETICAL FOUNDATIONS OF THE ANALYSES .............................................. 83 G METHODOLOGICAL PART ................................................................................... 86 H REFERENCES .................................................................................................... 105 Czech National Bank / Analyses of the Czech Republic’s economic alignment with the euro area 2017 TABLES AND CHARTS 3 Table 1: GDP per capita at purchasing power parity ........................................................................ 23 Table 2: Average price level of GDP .............................................................................................. 24 Table 3: Real exchange rate against the euro ................................................................................. 25 Table 4: Three-month ex-post real interest rates ............................................................................ 26 Table 5: Correlation coefficients of economic activity with the euro area ............................................ 30 Table 6: Correlation coefficients of exports to the euro area with euro area GDP ................................. 31 Table 7: Correlations of exchange rates against the US dollar .......................................................... 36 Table 8: Ratios of FDI stock from the euro area to GDP ................................................................... 40 Table 9: Ratios of DI stock in the euro area to GDP ......................................................................... 40 Table 10: Correlation between changes in rates on loans to non-financial corporations (fixed for up to one year) and changes in three-month market rates ............................................................................. 47 Table 11: Correlation between changes in rates on loans for house purchase and in market rates ......... 50 Table 12: Inflation persistence estimates ....................................................................................... 51 Table 13: General government balance (European Commission estimate) .......................................... 59 Table 14: Shares of mandatory state budget expenditure ................................................................ 60 Table 15: Public revenues and expenditures relative to GDP in 2016 ................................................. 61 Table 16: General government debt (European Commission estimate) .............................................. 61 Table 17: Debt service (European Commission estimate) ................................................................. 62 Table 18: Age-related government expenditures ............................................................................. 63 Table 19: Long-term unemployment rate ....................................................................................... 64 Table 20: Rate of economic activity in the 15–64 age category ......................................................... 66 Table 21: Coefficient of variation of the unemployment rate ............................................................. 67 Table 22: Internal migration ........................................................................................................ 67 Table 23: Share of foreign nationals in the population ..................................................................... 70 Table 24: Minimum wage ............................................................................................................. 71 Table 25: Ratio of the minimum wage to the gross monthly wage in selected professions .................... 72 Table 26: Overall labour taxation .................................................................................................. 73 Table 27: Conditions for starting and closing a business .................................................................. 77 Table 28: Non-performing loans ................................................................................................... 81 Table B1: Scoreboard for the early detection of macroeconomic imbalances ....................................... 18 Table B2: Average real appreciation .............................................................................................. 28 Table B3: