Miroslav Singer, Governor, CNB
OMFIF
Welcome address by Governor Miroslav Singer
Prague, 19th October 2015
Ladies and gentlemen,
Welcome to the Czech National Bank for the sixth Main Meeting in Europe co-organised by OMFIF and the Czech National Bank.
It’s not customary to show slides during a welcome address, but today I’m going to make an exception and show you two. I’m doing this because we are going to discuss growth, and in particular the fact that the growth we are currently seeing in advanced economies is lower than in the pre-crisis past.
That we are now experiencing slower growth should not come as any great surprise, given that the advanced economies have gone through the financial crisis supercycle and are now at the end of the Great Recession. Kenneth Rogoff has written about this with Carmen Reinhart. Claudio Borio and others have also studied financial cycles. As a result, it is politicians, not economists, who might be surprised at the low growth.
One of the more pertinent questions we should ask ourselves today, I believe, is: why has a financial crisis that started in the USA done most damage to growth in Europe? In my view, as economists we should be looking for the answer in three areas: structural (including Eurozone-related issues), fiscal and monetary. I will touch on each of these in turn.
The first area clearly has to do with the existence of the Eurozone. My first chart (Chart 1) reveals that a significant performance gap began to emerge between the Eurozone and the non-member states during the Great Recession. I should note that the chart shows the aggregate outputs of the current Eurozone and non-Eurozone EU members, so the statistical influence of Greece and other small economies on the Eurozone’s performance is negligible. It is in times of stress that systems get tested. The less the euro area satisfied the conditions of an optimal currency area, and the more its economies lacked an exchange rate adjustment mechanism, the more the existence of the euro area complicated the situation in some member states. One size did not fit all, because in past years some Eurozone economies would have needed a much greater monetary easing via interest rates than they actually experienced. However, every cloud has a silver lining, at least for those Eurozone economies which, in the absence of an exchange rate adjustment mechanism, implemented much-needed structural reforms. In Ireland, Spain and Portugal, economic growth is recovering.
Chart 1 - Real GDP growth: EMU vs non-EMU
(y-o-y change in %; quarterly data; seasonally adjusted and adjusted data by working days) 
Source: Eurostat, own computations
The second area is fiscal policy. It is well known that some European economies failed to comply with the relevant budget criteria in the past, and they paid the price for this during the Great Recession. However, it is hard to see that substantial a difference in the pre-crisis period between the Eurozone countries on the one hand and the USA and the UK on the other. In any event, fiscal policy was used much more forcefully in the USA, and even partially in the UK, than it was in the Eurozone countries during the Great Recession. There were three reasons for this: 1) there were investors willing to invest in USA and UK sovereign debt, 2) the USA and the UK had their own central banks with fully recognised ability to act as providers of liquidity and consequently as guarantors of state solvency, and, most importantly, 3) they had politicians who were willing to do what was needed. Fiscal policy was used properly in these two countries during the Great Recession. This is one of the reasons why they are both now coping better with the aftermath of the financial crisis.
The third area is monetary policy. The European Central Bank’s monetary policy was probably too tight before the financial crisis and was certainly tight during the Great Recession. In general, macroeconomic policies were also too tight, at least until the end of 2014. Here comes the second chart (Chart 2), which shows the euro-dollar exchange rate since 1971, the end of Bretton Woods. The pre-Eurozone rate is proxied using the euro legacy currencies on the basis of Eurostat calculations. The chart tells several stories. Among the most prominent is the existence of three roughly 13–14 year cycles of European vs. US currency developments. Those cycles are similar in appearance, despite, among other things, immense changes in economic geography and structure, the emergence of the Eurozone and changes in monetary policy frameworks. But now please note the euro’s extraordinary appreciation against the dollar between 2001 and the Lehman Brothers collapse. There were clearly no fundamental economic grounds for the major EU currency to strengthen by two-thirds. Unfortunately for the Eurozone, this appreciation drove its economy out of world markets, exactly at the moment when demand was falling around the world. As I have already mentioned, the chart shows three similar cycles of euro-USD developments during the last 43 years. Given that so much has changed in those years, one can speculate that some of these cycles signal somewhat broader and longer workings of democratic political mechanisms in the EU and the US, resulting, among other things, in repeating increases and decreases in the use of countercyclical monetary policies. Let me end with the last major trend in the chart, which I believe provides some hope for Europe and the EU: it appears there is a long-term mild appreciation trend of the major EU currency against USD.
Chart 2 - USD/EUR(ECU) exchange rate since end of Bretton Woods system 
Source: Eurostat
What does all this tell us? It repeats what we should have already known from the recent history of the Czech economy. Tight monetary policy combined with tight fiscal policy dragged the Czech economy down into a trough in 2013, bringing it to the verge of deflation. It returned to a growth path only after we started using our currency as an inflation targeting tool in November 2013 and our fiscal policy became broadly neutral. Over the last half-year, the Czech economy has become a star performer. I should add that this has taken many domestic economists by surprise.
To sum up, macro-matters and countercyclical macroeconomic policies are important. They can stabilise the economy in the short and medium term. It is evident, I believe, that the Czech National Bank has applied the right monetary policy over the last two years. Fiscal and structural policies are often cast in the role of scapegoat when monetary policy struggles to fulfil its mandate. Monetary authorities should not, as they often do, use other economic policies as an excuse. Central bankers should bear sole responsibility for inflation and not pin the blame on others. I’m glad that many of the discussions at the recent Jackson Hole symposium put a new emphasis on the three core principles of modern central banking, namely that central banks are responsible for inflation, that they must accept that responsibility and not wash their hands of it, and, finally, that despite the flaws in monetary policy transmission mechanisms they must steer the price level towards their inflation targets in the future. We at the Czech National Bank share these principles and try to fulfil them systematically and consistently in our monetary policy-making.
I’d like to conclude by praising the OMFIF’s initiative in organising this meeting. I regard the focus of the meeting as very topical and well chosen. I believe it is vital to seek answers to the issues raised on the agenda. I find it particularly important to assess the effectiveness of the ECB’s expanded asset purchase programme and to review QE in the US and Japan, as such analyses will help other central banks find the best ways of dealing with the current disinflationary environment. In other words, at this meeting we should seek ways of moving our economies to normal and stable growth equilibria.
Thank you for listening. I’m sure that our meeting today will be very interesting and extremely useful to everyone here.