MONETARY POLICY REPORT | SPRING 2023 (appendix 1)
(authors: Tatiana Keseliová, Karel Musil, Tomáš Pokorný, Tomáš Šestořád, Stanislav Tvrz, Jan Žáček)
Retrospectively assessing the fulfilment of forecasts is part of the CNB’s forecasting and analytical system. These analyses provide feedback on the functioning of the g3+ core forecasting model, which is the basic and unifying element used in preparing the CNB’s macroeconomic forecasts. The conclusions of these analyses are used to verify the model’s current settings and to consider potential adjustments to them.[1] This Monetary Policy Report continues in the tradition of publishing an annual summary of these analyses. This is consistent with the high transparency of the CNB’s forecasting practice and monetary policy.
The CNB’s macroeconomic forecast serves as an important guide for the Bank Board when setting interest rates. The tool used to create the forecast is the g3+ core forecasting model. The forecast predicts the most probable future evolution of the domestic economy and the domestic interest rate path consistent with this which ensures the achievement of the CNB’s inflation target at the monetary policy horizon.
In this appendix, we first assess the fulfilment of the forecasts[2] prepared in 2021, starting with a comparison of their assumptions (the exogenous factors of the forecast) and the observed developments. We then compare the forecasted paths of the main domestic variables with the data observed now. In the following part, we provide a hypothetical model simulation. This shows approximately what the forecast in the Autumn 2021 Monetary Policy Report would have looked like if what was subsequently observed, i.e. the future evolution of all the assumptions entering the forecast, had been known at the time of its preparation. The final, new section of the appendix is devoted to comparing the CNB’s forecasts published in 2021 with the outputs of other analytical institutions.
Assessment of the fulfilment of the 2021 forecasts – assumptions
The main assumption of the CNB’s macroeconomic forecast for the domestic economy is the outlook for the foreign environment.[3] The expectations of renewed growth in economic activity in the effective euro area in 2021 practically materialised.[4] The return of economic life abroad to normal after the lifting of anti-pandemic measures was in fact only slightly faster than the outlooks at the time had expected. In the second half of 2021 and in 2022, by contrast, GDP in the euro area grew more slowly than forecasted in 2021. This was due initially to stronger impacts of the disruption to global value chains (GVCs) constraining the production side of the economy, which was unable to satisfy the swiftly recovering demand supported by the spending of pandemic-induced forced savings and the related deferred consumption. This was later joined by the negative impacts of the energy crisis in Europe and the outbreak of the war in Ukraine, which exacerbated the energy market situation and shook consumer confidence.
The impact of the Covid waves was gradually revised in the CNB’s 2021 forecasts in favour of greater effects on potential output growth (the supply side of the economy) amid an only limited decrease in the output gap (see Chart 1).[5] This was because supply was hit by restrictions imposed on firms during the various waves of the pandemic, later joined by disruption and overloading of GVCs. With the benefit of hindsight, however, we can say that the forecasts under assessment underestimated the demand pressures in the effective euro area. According to current estimates, the output gap in the effective euro area has been positive since the second half of 2020 and started to close from above at the end of 2022. By contrast, the 2021 forecasts expected the negative output gap to widen again at the start of 2021 and then gradually close from below, as demand (and hence the demand-driven inflation pressures) fell to only a limited extent, while the GVC disruptions led to distinctly stronger supply-side inflation pressures.
The unprecedented surge in foreign producer price inflation (see Chart 1) in 2021 and 2022, driven largely by an extreme jump in energy prices, was forecasted only partly, to the extent corresponding to the pass-through of energy commodity futures at the time. Low gas stocks in Europe before the approaching 2021/2022 winter, together with reduced energy commodity supplies from Russia, fostered a rapid rise in energy commodity prices on European markets in 2021. The situation deteriorated further after Russia’s invasion of Ukraine in February 2022. European countries’ efforts to fill their gas storage facilities ahead of the 2022/2023 winter, combined with increased demand for gas due to shortages of other sources of electricity[6] and a simultaneous shift away from Russia as an energy commodity supplier, caused gas prices to up further. Core foreign producer prices in the effective euro area also rose much faster than originally assumed, reflecting both stronger demand pressures in an environment of disrupted GVCs and the pass-through of the increased energy costs in the price vertical.
While the 2021 forecasts expected monetary policy in the euro area to remain largely unchanged, the ECB in fact started to raise its key interest rates gradually at the end of July 2022. The 3M EURIBOR market rate thus gradually increased from negative levels to 3% at the start of 2023 (see Chart 1). The ECB’s monetary policy was also less loose in its unconventional component on average than in the assumptions of the forecasts under assessment. The de facto constant volume of purchased assets in the ECB’s balance sheet had a broadly neutral effect from the second half of 2022 onwards. The war in Ukraine, together with a slower response of the ECB’s monetary policy to the rising inflation pressures compared to the US Fed, resulted in a significantly weaker exchange rate of the euro against the dollar than expected in the forecasts under assessment.
Chart 1 – Selected forecast assumptions
Except in 2021 Q4, when there was a temporary waiver of VAT on electricity and gas (in November and December), the observed growth in administered prices in the domestic economy was well above the assumptions of the forecasts under assessment over the entire horizon (see Chart 1). At the start of 2022, the previous unexpectedly strong growth in energy prices on international exchanges began to be reflected in administered prices, hence their growth also exceeded that assumed in the Autumn 2021 MPR forecast. Administered price inflation dipped at the end of 2022 due to the temporary introduction of an energy savings tariff by the government (which led to a fall in electricity prices). Even so, it remained much higher than originally assumed. After the energy savings tariff was ended at the start of 2023, administered price inflation surged again, reaching an all-time high.
Growth in nominal government consumption and the fiscal impulse, another domestic assumption, was roughly in line with the forecasts under assessment. At the start of 2022, government expenditure increased more significantly than forecasted owing to the support provided to Ukrainian refugees arriving into the country.
Assessment of the fulfilment of the 2021 forecasts – main domestic variables
In the course of 2021, headline inflation increasingly exceeded the forecasts at the time (see Chart 2). Unexpectedly rapidly rising price pressures in the foreign and domestic economies led to an initially gradual and later sharp rise in inflation. The higher-than-expected growth in prices was mainly due to supply-side, or cost, effects, especially the unexpected surge in energy prices and the stronger-than-forecasted effects of the disruption of GVCs. The substantial surge in growth in domestic firms’ costs was not captured until the autumn 2021 forecast, and then only partially (see Chart 2). However, stronger demand pressures – among other things, a greater willingness by households to tolerate higher prices – also fostered higher inflation to some extent. This was mainly due to more reckless spending of pandemic savings than originally expected and to a better labour market situation amid continued excess demand for labour. Persisting labour market tightness thus reduced the effect of the rising cost of living on household consumption, mainly as a result of a still low unemployment rate. The rising inflation started to be reflected with a lag in wage growth as well. As with costs, in the case of the profit margins of domestic firms producing for domestic consumption, it was not until the autumn 2021 forecast that their increased profitability was partially identified (see Chart 2). In hindsight, however, the margins of domestic producers were much higher during 2022.
For most of 2021, the 3M PRIBOR market interest rate was roughly in line with the forecasts at the time, which increasingly identified a need for strong monetary tightening (see Chart 2). In reality, domestic market interest rates continued to rise in the first half of 2022, while the 2021 forecasts had expected relatively stable rates in 2022, close to the policy-neutral level of 3%. The mostly energy crisis-related surge in inflation continued to grow during 2022. In addition to prices, wage growth exceeded the expectations of the forecasts under assessment.
Domestic economic activity was somewhat better than forecasted in 2021 (see Chart 2). Deferred consumption and the spending of forced savings created during the pandemic shutdowns were somewhat stronger than the forecasts under assessment had expected, despite higher inflation and greater problems in production due to the disruption of GVCs.[7] Conversely, real economic growth in 2022 mostly lagged behind the 2021 outlooks. Worsening consumer sentiment due to the war in Ukraine and the energy crisis, along with price impacts in the form of a real decline in wages, led to a sharp drop in real household consumption and hence also to lower overall domestic GDP growth in the course of 2022. Tighter monetary policy – in the shape of higher interest rates than implied by the forecasts under assessment – also ultimately contributed partially to the larger-than-forecasted GDP slowdown.
The koruna exchange rate was quite volatile in the period under review. In terms of the quarterly averages, however it strengthened continuously, broadly in line with the forecasts (see Chart 2). This was initially due to the gradual return of the economy to normal after the pandemic shutdowns and the related positive sentiment on foreign exchange markets. The latter was fostered from mid-2021 onwards by growth in domestic market interest rates, which made the koruna more attractive. In 2022, the exchange rate of the koruna against the euro was stabilised by occasional foreign exchange interventions by the CNB and by its communicated readiness to suppress excessive fluctuations of the koruna exchange rate. The need for the CNB to intervene was most apparent after Russia’s invasion of Ukraine, when, in late February and early March 2022, the koruna depreciated from around CZK 24.5 to CZK 26 to the euro in just a few days. The CNB also occasionally intervened in favour of the koruna during the rest of 2022 (in fact until October). There was a wave of positive sentiment on foreign exchange markets in late 2022 and early 2023 due to the mild winter and the relatively well handled energy crisis in Europe, which helped all Central European currencies.
Chart 2 – Forecasts of main domestic variables
Note: The actual values in the charts showing total costs and gaps in profit mark-ups are approximated by the current forecast in the Spring 2023 Monetary Policy Report, as these are unobserved variables from the perspective of the g3+ core forecasting model.
The hypothetical factors-known Autumn 2021 MPR forecast
The factors-known simulation is a hypothetical version of the Autumn 2021 MPR macroeconomic forecast. As with that forecast, the hypothetical simulations were created using the g3+ core forecasting model with the standard monetary policy horizon 12–18 months ahead.
A factors-known simulation is a conditional simulation of the g3+ model representing a hypothetical version of the forecast incorporating knowledge of the actual evolution of the exogenous factors (assumptions) of the forecast. The simulation reflects the observed data (the ex-post known paths of the foreign environment, administered prices and government consumption). It thus tells us what the hypothetical forecast would have looked like if the observed evolution of its assumptions had been used in its preparation. The simulation is not a fully fledged forecast, as in this case, too, additional expert adjustments would probably be made which would significantly affect the simulation.
However, in the course of 2022, the CNB decided (amid increased uncertainty after Russia’s invasion of Ukraine) to exclude part of the inflation pressures caused by the extreme supply shocks and so disregard the direct effects of these shocks on inflation. A natural consequence of this step was a shift of the time period on which the monetary policy makers focus when making their decisions further into the future. The monetary policy horizon thus moved to a period in which the expected first-round effects of the supply shocks on inflation should have faded out and only longer-term secondary effects should have persisted in the economy.[8] The potential impacts of the alternative monetary policy horizon are illustrated by an auxiliary simulation involving an additional assumption of a monetary policy horizon 18–24 months ahead. In addition, this simulation considers the additional exemption of part of the supply shocks, which would imply a higher interest rate than the 7.3% actually attained.
We first compare the difference between the original forecast and the hypothetical factors-known simulation. We then assess the deviations of this simulation from the observed historical outcome. At the end of this section, we then assess the implications of the more distant monetary policy horizon based on the auxiliary simulation. Overall, the factors-known simulation implies an ex-post need for considerably tighter monetary conditions than those actually set. In the case of this standard forward-looking response by the central bank, especially to the cost pressures which were actually faced by the domestic economy, the evolution of other economic variables would then also have been markedly different. The auxiliary simulation featuring a more distant monetary policy horizon, which more faithfully captures the CNB’s behaviour at the time, is thus close to the paths that were actually observed.
Comparing the hypothetical factors-known simulation with the Autumn 2021 MPR forecast, headline inflation is above the original forecast over the entire forecast horizon (see Chart 3) and well above the CNB’s 2% inflation target. This is due mainly to rapid growth in foreign producer prices and to the impacts of the energy crisis, which affects the domestic economy through two channels, first via import prices and the cost channel in domestic production and second via administered prices directly into households’ consumer baskets (especially heat and electricity). In the simulation, the central bank reacts immediately to this outlook in a forward-looking manner. After a temporary increase, inflation thus returns to its 2% target in the hypothetical simulation. However, to achieve this consumer price inflation path, the need arises for a much larger interest rate hike (in double figures) in the hypothetical simulation than in the forecast under assessment. Again, this is mostly due to the external assumptions of the forecast, including higher foreign interest rates. However, a more inflationary effect of the domestic economy in 2021 also partially contributes to the difference. The leap in domestic interest rates at the end of 2021 and their further rise during 2022 leads to a substantially stronger koruna and also to significantly more subdued domestic economic activity overall in the hypothetical simulation. This is because the stronger koruna in the hypothetical simulation reduces domestic exporters’ competitiveness and leads to a year-on-year decline in exports lasting until mid-2022. The labour market also subsequently responds to this with a slight drop in nominal wages in 2022, while the forecast under assessment expected roughly steady-state nominal wage growth. This drop would have fostered a deeper decline in household consumption, especially in 2022.
Comparing the hypothetical factors-known simulation with the historical outcome, observed inflation was well above the simulation over the entire forecast horizon. In reality, the extent of the energy crisis was not known in advance and the central bank reacted to new information gradually and with a lag. Therefore, the increase in interest rates and appreciation of the koruna were not as rapid and sharp in reality as the hypothetical simulation shows. Consequently, the necessary reduction in domestic economic activity and easing of labour market tightness were not delivered either. The domestic economy in reality thus remained inflationary and households were willing and able to accept higher inflation. Some firms took advantage of this, contributing to inflation by increasing their mark-ups. From the second half of 2022 onwards, escape clauses also play a significant role in the comparison of the interest rate path in the hypothetical simulation with the actually observed path. Model simulations created during 2022 using the core forecasting model with the standard monetary policy horizon, i.e. reacting to the expected inflation outlook 12–18 months ahead, indicated a need for a further rise in the 3M PRIBOR above 10%. In reality, however, it has remained just above 7% since the last increase in the CNB’s policy rates in June 2022.
The auxiliary hypothetical simulation featuring a more distant monetary policy horizon (18–24 months ahead) initially implies a similarly rapid rise in interest rates as for the standard horizon. Even with this setting, the central bank is forced to react to the outlook for extreme growth in foreign producer prices and administered prices during 2022, and in particular to its second-round effects. After reaching the current level of 7.3%, domestic market 3M PRIBOR rates then remain at this level in the simulation until the end of the period under review. The path of the exchange rate is consistent with this – the rate does not appreciate as strongly and subsequently starts to depreciate earlier than in the baseline factors-known simulation. Domestic consumer price inflation therefore ultimately attains higher levels, in line with the logic of the shift of the monetary policy horizon, and recedes more slowly and later than with the standard horizon. Unlike in the simulation with the original monetary policy horizon, headline inflation does not fall into the tolerance band even at the end of the period under review. The decline in GDP in 2022 is noticeably shallower in the auxiliary simulation. The generally more accommodative monetary conditions manifest themselves mainly in a less pronounced drop in household consumption. The weaker exchange rate also supports net exports.
Chart 3 – Comparison of the forecast and the factors-known simulation (hypothetical forecast) in the Autumn 2021 MPR with the observed data
light-grey area in charts shows Autumn 2021 MPR forecast horizon
The 2021 forecasts compared to other institutions
The final section offers a comparison of the CNB’s 2021 forecasts with the contemporary outputs of other analytical institutions. Chart 4 shows the forecasted and subsequently observed main variables under review in whole-year terms for 2021 and 2022.
In the case of consumer price inflation, the institutions’ 2021 and 2022 forecasts were initially anchored at the CNB’s 2% inflation target. However, the uncertainty of the forecasts gradually increased during 2021. Information on surging producer price inflation in the effective euro area and significantly increasing gas and electricity prices gradually started to pass through to the forecasts. In summer 2021, the forecasts thus abandoned the assumption of achievement of the 2% target in 2021 and subsequently also in 2022.
On average, the CNB’s forecasts were generally higher than the estimates of other institutions and thus closer to what actually happened. The CNB’s autumn 2021 forecast estimated the resulting inflation rate for 2021 most accurately and for 2022 also already gave quite a clear indication of the persistence of the surge in inflation into the future. However, the full scale of the inflation surge was not successfully predicted.
Chart 4 – Comparison of the CNB’s 2021 forecasts with those of other institutions (full-year data for 2021 and 2022)
The data sources are the CNB’s forecasts and the Ministry of Finance (MoF) survey published in the 2021 Macroeconomic Forecast of the Czech Republic. The MoF survey is based on the publicly available forecasts of 13 institutions, eight of them domestic (CNB, Czech Banking Association, MLSA and domestic commercial banks) and the others foreign (e.g. European Commission, OECD, IMF). For the purposes of this document, the CNB’s forecasts are excluded from the survey and the MoF’s forecasts are included. In its winter forecast (and in the survey), the MoF did not publish data for 2022 in whole-year terms and hence the data are missing.
Example: the blue CNB dot corresponding to “spring 2021” in the “GDP for 2021“ chart shows the full-year GDP growth estimate for 2021 from the forecast published in spring 2021 (i.e. the Spring 2021 MPR).
Institutions other than the CNB initially expected roughly steady-state 3% domestic economic growth for 2021. Later their estimates increased slightly. The wide ranges of the estimates reflected the increased uncertainty of the forecasts amid the gradually receding pandemic.[9] The dispersion of the GDP growth forecasts for 2021 only decreased significantly following the publication of the CZSO’s initial estimates in the second half of 2021. The estimates for 2022 expected higher growth rates of around 4% connected with further catch-up after the pandemic contraction amid gradually fading problems in global value chains, but also amid continued significant uncertainty.
In its economic growth forecasts for 2021, the CNB was generally much more pessimistic than the other institutions. Its first three 2021 forecasts underestimated the scale of the household consumption recovery and also underestimated the downward effects of disrupted GVCs on export growth. The autumn 2021 forecast estimated household consumption and exports almost exactly. The resulting underestimation of GDP growth was due to smaller assumed growth in inventories. As for the estimated GDP growth for 2022, the CNB’s forecasts were virtually in the middle of the range of the other institutions. Only the autumn 2021 forecast was slightly more pessimistic, but as a result it was the closest to the actual value, because domestic economic growth in 2022 was below all the 2021 estimates. This was due, among other things, to a sizeable decline in real wages and domestic demand amid high consumer price inflation, which the forecasts at the time did not expect to such an extent.
At the start of 2021, the institutions were predicting only moderate growth in the average nominal wage, whereas their subsequent forecasts already reflected the observed upswing in inflation and wage growth. The estimates for 2021 and 2022 thus gradually shifted to close to 5%.
The CNB’s nominal wage growth estimates for 2021 were generally higher than those of the other institutions’. They were expecting growth of about 5% throughout 2021. However, the CZSO’s initial estimate exceeded 6% (the final estimate after revisions was almost 5%). Taking the estimates for 2022, the CNB’s forecasts, with the exception of the last forecast under assessment, were close to the average of the other institutions’ estimates. In line with the persistent inflation, the autumn 2021 forecast also expected persisting increased wage growth. It was thus one of the highest of the forecasts under comparison and simultaneously was closest to what was subsequently actually observed.
To sum up, the accuracy of the CNB’s forecasts for domestic economic activity was comparable to that of the 2021 forecasts of other analytical institutions, although the estimates for 2021 were more pessimistic on average. In the case of consumer price inflation and nominal wage growth, the CNB’s forecasts were generally among the more accurate of the outlooks under comparison.
[1] The forecast arises on the basis of debates involving many economists and monetary policymakers, whose views are incorporated into the forecast in the form of expert adjustments. The core model serves as a unifying framework ensuring the necessary macroeconomic consistency. However, the model still has to demonstrate a good predictive ability, and regular quality control is more than desirable.
[2] The choice of forecasts included in this analysis is determined by the availability of observations, which must cover the monetary policy horizons of the forecasts under assessment. The last forecast which can be included in the analysis is the Autumn 2021 MPR one.
[3] The specific indicators considered are industrial producer prices in the effective euro area (broken down into their core and energy components), foreign economic activity (the GDP trend and the output gap in the effective euro area), the USD/EUR cross rate, the Brent crude oil price and the 3M EURIBOR interest rate and its shadow component capturing the ECB’s unconventional monetary policy measures (asset purchases). The domestic assumptions include the outlook for administered prices and nominal government consumption along with its deflator and the fiscal impulse.
[4] The differences between the predicted effective euro area GDP paths and the observed outcomes stem mainly from revisions of the historical data.
[5] The CNB analysed the nature of the economic shocks associated with the Covid-19 pandemic in, for example, Assessment of the nature of the pandemic shock: Implications for monetary policy, Oxana Babecká Kucharčuková, Jan Brůha, Petr Král, Martin Motl, Jaromír Tonner (2022), CNB RPN 1/2022.
[6] Shutdowns of nuclear power stations in France and limited wind generation in Germany led to increased demand for electricity from gas power plants in 2022. The exchange price of gas thus peaked at more than ten times the pre-crisis highs in late summer 2022.
[7] On the other hand, production and exports in the industrial sectors of the domestic economy, especially the automotive industry, were significantly reduced in 2021 and in the first half of 2022 by disruptions to material and component supplies as a result of overloaded global supply chains. This was reflected mainly in higher additions to inventories relative to the forecasts under assessment.
[8] When setting monetary policy interest rates during the period under review, the CNB Bank Board first took into account a simulation featuring a more distant monetary policy horizon contained in the Spring 2022 MPR. This then became the baseline scenario in the subsequent summer forecast. A monetary policy horizon 18–24 months ahead, i.e. six months further into the future than the former one, was considered in both cases. The need for exemptions decreased as the situation on energy commodity exchanges started to calm in the autumn. The forecast in the Autumn 2022 MPR therefore employed a monetary policy horizon 15–21 months ahead. The Winter 2023 MPR forecast then returned to the original horizon 12–18 months ahead.
[9] In addition to the precise timing of the lifting of pandemic restrictions, there was significant uncertainty surrounding the extent of the subsequent domestic demand recovery supported by the spending of forced savings and by deferred consumption. On top of that, the restart of the global economy in 2021 Q2 was complicated by disrupted GVCs. The still partially constrained production facilities were unable to react flexibly on the global scale to the sudden rise in demand. Complex manufacturing sectors such as the automotive industry were hit particularly hard by disruptions to key material and component supplies.