By Mojmír Hampl (Visegrad Insight 7. 12. 2015 page 52)
The main reason why the Czechs should keep the koruna can be expressed neatly by the wise adage: “if it ain’t broke, don’t fix it;” and the monetary policy in the Czech Republic is simply not in need of fixing. Since 1998, the Czech National Bank has been using an inflation targeting framework to steer its monetary policy with notable success. After an initial period of disinflation, the CNB has been able to keep inflation expectations close to its set targets. More specifically, the goals were to have low, positive levels of inflation which it considers the most effective match for price stability. In the view of the CNB, inducing inflation expectations to hover near price stability is the best that monetary policies can achieve in order to nurture robust investment and support the sustainable growth of the economy.
A welcome implication of low average inflation has been a trend of real appreciation – as implied by economic convergence to Western European peers – which has resulted, at least nominally, in an advantageous exchange rate.This strengthening of the exchange rate has taken place at a mostly moderate pace. One notable exception was the first half of 2002, when the pace of appreciation became rather dramatic, mostly due to expectations of recently privatized properties transferring to foreign investors and entities. But the CNB and the Czech government took lessons from that episode and, since then, the two institutions have exhibited a high degree of mutual policy communication and coordination. As a result, the foreign exchange market has had little reason to speculate on any exchange rate-sensitive, domestic policy blunders.
Another fruit of the long-term price stability has been a low level of nominal interest rates. Thus, the domestic market has had no reason to demand loans in foreign currencies – a product which, in recent years, has caused so much trouble and public discontent in some other Visegrad countries.
Needless to say, the actual price developments have been dramatic whether due to domestic policy changes, such as indirect tax changes, or due to shocks coming from abroad, such as swings in the price of oil. But this is and always will be the case for any small open economy, regardless of who determines domestic monetary conditions. Forcing actual inflation to stay close to the target at all times would perhaps be possible, but only at the cost of sizeable monetary policy shocks, which would have adverse implications for the real economy.
In fact, developments in recent years have only reinforced the idea that autonomous monetary policy, if conducted properly, is an advantage. Just compare the Czech and the Slovak cases. In both economies, the relevant monetary policy authority has hit the lower boundary on nominal interest rates. However, the Czech authority (the Czech National Bank), unlike the Slovak one (the European Central Bank), was able to start using the Exchange rate between the local currency and the euro as a supplementary monetary policy tool in an effort to avoid deflation and to bring inflation back to the target. I would assume that, as a result, future longer-term inflation expectations will be better anchored near price stability in the Czech Republic than in Slovakia.
There would be little need for such use of autonomous monetary policy if at least one of the two following conditions were met. Either the Czech economy would have to be very similar to that of the euro area so that the European Central Bank’s monetary policy stance would be appropriate for the Czech economy as well. Or the Czech economy would have to be flexible enough to easily weather any mismatch between the monetary policy stance it actually needs and whichever stance the ECB takes. None of these two conditions, however, have been met. The set of comparative analyses that the CNB has produced at the end of every year since 2005 shows that the two economies differ considerably, and that neither the Czech labor market nor the public coffers are ready to work as a reliable adjustment valve.
To sum up, the CNB’s monetary policy seems to have earned quite a lot of credibility. Indeed, a survey in April 2015 showed that almost 70% of Czechs are more or less against adopting the euro. This general feeling can also be documented by deeds; despite its geographical proximity to, and close trade links with, the euro area, the degree of spontaneous eurosisation within the Czech economy is low – in comparison with Poland and Hungary – and is not growing.