The objective of monetary policy

The CNB's monetary policy objective according to the Act on the CNB

The CNB´s monetary policy objective is set forth in Article 98 of the Constitution of the Czech Republic and in Article 2 of Act No. 6/1993 Coll., on the Czech National Bank. In particular, the CNB is required to maintain price stability. Without prejudice to its primary objective, the CNB shall support the general economic policies of the Government leading to sustainable economic growth.

The central banks of most democratic nations with market economies have a similar objective. The objective of maintaining price stability, i.e. of fostering a stable environment for the development of entrepreneurial activity, reflects the central bank's responsibility for sustainable economic growth. A necessary condition for implementing monetary policy leading to price stability is central bank independence.

The CNB endeavours to fulfil this objective within a monetary policy regime known as inflation targeting. In the pursuit of its objective, it uses several monetary policy instruments.

Price stability

Like most central banks, the CNB focuses on stability of consumer prices. In practice, price stability does not literally mean unchanging prices, it means moderate growth in prices. The level of inflation corresponding to price stability should encompass the upward statistical deviations that arise in the measurement of inflation, and should also allow sufficient room for the small changes in relative prices that occur constantly in every economy with an effective price system. An inflation target of 3 % (pdf, 76 kB) with a tolerance band of one percentage point in either direction was announced for the period from January 2006. In March 2007, a new inflation target of 2 % (pdf, 29 kB) was announced with effect from January 2010. As before, the CNB will strive to ensure that actual inflation does not differ from the target by more than one percentage point on either side

The costs of inflation, or why price stability?

High and volatile inflation has adverse implications for economic growth. This is confirmed by the long-term empirical experience from the world economy. High inflation erodes the value of incomes and savings and leads to high nominal interest rates.  As a rule, it also implies considerable inflation volatility, which substantially increases the costs of inflation. This is because high inflation increases the uncertainty about future relative prices and about the price level, and so domestic and foreign financial markets require a higher risk premium as compensation for this increased uncertainty. When inflation is high in the long term, inflation and depreciation expectations generally become fixed in the decision-making of economic agents. Because of the greater inflation volatility, investors focus more on short-term financial investments (speculative activities) and on hedging against inflation, and less on longer-term investment projects in the real economy. Unforeseen inflation causes several other economic distortions that reduce the long-term growth potential of the economy: it redistributes income from creditors to debtors, creates distortions in the tax system, and represents a hidden burden on savers, who are unable to safeguard the purchasing power of their incomes and savings. Another disadvantage of high inflation is high interest rates. These stimulate inflow of short-term risk capital, which has a range of direct and indirect adverse effects.