In a period of double-digit inflation, monetary policy unsurprisingly becomes the subject of public debate. Although the Czech National Bank (ČNB), or rather the Banking Council, in the first half of last year, from the point of view of the history of monetary policy, tightened its monetary policy extremely sharply, it still finds itself in the focus of criticism.
A report by the International Monetary Fund (IMF), which recommends further rate increases, also contributed to the latest wave of criticism. At the same time, however, relatively extreme views on monetary policy appear, unfortunately sometimes also from the mouths and pens of personalities who enjoy the reputation of qualified economists. Sunday’s debate on Czech Television painfully reminded me of this.
However, in the following, I dare to claim that the current monetary policy of the CNB is at least quite reasonable from the point of view of the current development of the economy. The real question is whether will be reasonable.
But first of all, it should be noted that the current wave of inflation represents a development that the advanced economies, to which we belong for some time, have not seen it for several decades. It is from this point of view that it is good to evaluate not only possible mistakes of monetary policy or forecasts of central banks, but also the recommendations of other institutions, such as the IMF.
In almost 12 years at the central bank, I have experienced situations where I could agree with the recommendations of the IMF, and situations where I could not. Sometimes the CNB was right, sometimes the IMF, sometimes no one.
This is part of the monetary policy making process. Much more important for the interpretation of the current disagreement, however, is that since it was recorded, we have other signals about the state of the Czech economy, which tend to prove our central bank to be right.
Let us recall first that the subject of criticism is the reluctance of the majority of the members of the bank board to follow exactly the CNB model, which assumes a further increase in rates for a relatively short period – a tightening of monetary policy.
Such situations, when monetary policy smooths out the model’s recommendations, have been there many times before. But more importantly, so far core inflation is lower than the model predicts. This type of inflation best indicates price increases driven by domestic demand, and therefore also the part of inflationary factors that monetary policy should primarily influence. In other words, the need for hardening is evidently lower today compared to the assumptions of the CNB model.
Furthermore, it should be noted that the exchange rate of the koruna is, on the contrary, significantly stronger than the model assumes, and part of the tightening of monetary policy, which the model assumes, is therefore realized through the exchange rate channel. This should not come as much of a surprise to more educated participants in the monetary policy debate.
It is not easy to model that the central bank’s willingness to intervene against a weakening of the Czech currency below a certain limit leads to a different than symmetrical balance of exchange rate risk for those who speculate on it. In layman’s terms, in such a situation, a stronger exchange rate can be expected against the forecast.
In addition, the data from the economy so far indicate that the wage spiral is not turning in our country, and even with all the exceptionality of last year’s pre-Christmas situation, it should be added that it does not even seem that the Czech consumer has decided to face the wave of inflation by spending or investing.
This is undoubtedly because part of society no longer has reserves, but at the same time it also signals that those who still have reserves or can borrow are definitely not convinced that high inflation will be with us for a long time.
The long-term inflation risk thus remains two phenomena. Low unemployment and the reluctance of primarily developed European economies, including ours, to resort to budgetary measures that reduce the deficit more sharply (in the context of the debate on inflation, it is worth noting that in the fiscal area, on the other hand, the IMF recommends caution with cuts).
The low unemployment reflects the fact that not only in our economy today, the declines due to the increase in energy prices are lower than generally expected. Of course, this also means that there is really no reason to worry about reports of layoffs or production ending somewhere. If we reach a situation that, on the other hand, will require a looser monetary policy, there is more than enough room for the CNB to lower interest rates.
However, I would also like to point out that in the current debate on monetary policy, one can also observe quite strange stories that have nothing to do with reality. The first of them, I am a little afraid, or I hope, unintentionally supported by the communication of some representatives of the CNB, relates the current high inflation to the loosening of the monetary policy that central banks, including ours, carried out in the last decade.
The problem with this story is not only that it assumes a much longer than empirically observed transfer of monetary policy to inflation numbers, but mainly that the current inflation values in individual countries are completely at odds with the degree of monetary policy easing that their central banks have carried out in the last decade .
In other words, if the current high inflation was the result of the monetary easing carried out after the onset of the so-called Lehman crisis in 2008, inflation should definitely be dramatically higher in Switzerland or Great Britain than here or even in Hungary. Which it isn’t.
The current inflation in our country is also not caused by the fact that the central bank, by tightening monetary policy, introduced higher inflationary expectations into the Czech economy. This is what Jan Švejnar tries to assert repeatedly, pointing to the coincidence of the period when core inflation began to rise in our country with the period of rate increases.
If this were the case, core inflation would have to be significantly lower even in those Eurozone economies where rates rose significantly later and more slowly, which are similar to us in their openness, the state of their labor markets and their recent dependence on energy from Russia, for example in the Baltics or Slovakia.
But that is not the case, core inflation in these countries shot up very similarly, and the real difference can be found in the fact that here, but also in Poland, it is starting to fall as a result of significantly more restrictive monetary policy.
Where does inflation stop?
However, this does not mean that monetary policy is clear today. It is quite evident that inflation will return to single-digit values in our country this year. But the real question is where it stops and stabilizes. That is, whether stabilization will really occur at the two percent target of the central bank, or whether the fall in inflation will stop somewhere higher – for example, at levels around four to six percent.
It must be said that at the moment it is extremely difficult, if not impossible, to try to look for observable signals in the economy that would allow us to distinguish between the two scenarios. We will probably guess something in the second half of this year, it will be difficult before.
From this point of view, the debate that undoubtedly took place in the central bank between two dissenting members of the bank board and the majority of its members is probably more understandable.
The former demand a further increase in the rate so that a scenario in which inflation returns to the set target is more likely, even at the cost of an even more drastic impoverishment of the Czechs and the Czech economy.
To sum it up, with the advantage of hindsight, it can certainly be stated that monetary policy should have been more restrictive already in the period when it determined today’s inflation values - that is, already in the second half of 2020 and in the first quarter of 2021.
However, this does not change the fact that last year’s tightening of monetary policy was a belated but appropriate response to the given situation.
The current wave of inflation neither in our country nor elsewhere was caused by anything that took place in monetary policy rather in the first half of the last decade, let alone the tightening of monetary policy by central banks last year.
At the moment, it is evident that the CNB’s current policy will return inflation to lower, single-digit values at the end of this year. The big question not only for our central bank, however, is whether inflation will really return to the two percent inflation targets in a world of still relatively low unemployment and, to put it politely, little fiscal discipline.
I believe that the fair answer to this question today is “we don’t know, but – hopefully – we’ll see in time this year”.
