New steady-state settings in the g3 model
The rates of steady-state growth and equilibrium appreciation of the exchange rate and the foreign equilibrium interest rate in the g3 prediction model have been adjusted in the current forecast (see Table 1). This adjustment replaces the expert adjustments made in previous forecasts and therefore has no major impact on the changes compared to the previous forecast. The change in settings is based on the assumption that post-crisis productivity growth rates in the Czech Republic and the euro area will not reach the levels observed before 2008 over the next 3–5 years. The adjustment of these variables also reflects the more advanced stage of convergence of the Czech economy to the euro area compared to the period when the g3 model was developed and put into forecasting practice.1 The parameters of the model were set using an evaluation of historical data and the results of available analyses of the nominal and real convergence of the Czech economy to the euro area.
Table 1 (BOX) Steady-state growth setting
The rates of steady-state growth and equilibrium appreciation of the koruna have been reduced in the settings of the g3 model
(year on year in %)
|Original value||New value|
|Exchange rate appreciation||2.4||1.5|
|Domestic interest rate||3.0||3.0|
|Foreign interest rate||4.0||3.5|
The assumed steady-state rate of growth of the Czech economy has been lowered from 4% to 3% (since the end of 2012 the CNB forecasts had already been based on an expert judgement that the supply-side growth of the Czech economy after the unwinding of the crisis would be close to 3%). The 0.9 percentage point decrease in the equilibrium (nominal and real) rate of appreciation of the koruna against the euro reflects, in addition to the lower growth differential of the Czech economy vis-à-vis the euro area, the higher degree of price level convergence achieved in the pre-crisis period. As a result of the less pronounced exchange rate appreciation, the equilibrium contribution of import prices to inflation is stronger, but at the same time the contribution of the Balassa-Samuelson effect (export-specific technology) to inflation has been revised down.
A decrease in the steady-state rate of growth of effective external demand of 0.3 percentage point reflects the structural problems of some euro area countries and the negative impact of overindebtedness of both the public and private sector on the euro area’s growth potential. These factors also explain the assumed decrease in the real equilibrium interest rate, which also implies a proportional decrease in nominal interest rates assuming unchanged inflation abroad. The Czech economy (unlike some euro area countries) is currently facing no debt or structural problems leading to a decline in the equilibrium interest rate. The equilibrium real interest rate in the Czech Republic therefore remains at 1%, implying a nominal domestic interest rate of 3% given an unchanged inflation target of 2%. Moreover, the lowering of the rate of equilibrium real appreciation in a small open economy generates – following the logic of uncovered interest rate rarity – upward pressure on real rates, thereby offsetting the factors acting in the opposite direction, namely the aforementioned lower equilibrium interest rates in the euro area coupled with a continuing decline in the Czech Republic’s risk premium.
1 The steady-state growth rate of the domestic economy had already been lowered once since then, from 5% to 4%.