Speech at the conference to mark the 80th anniversary of the founding of the National Bank of Czechoslovakia
It was exactly 80 years ago, on 1 April 1926, that the National Bank of Czechoslovakia, the central bank of the young Czechoslovak Republic, started operation. At the inauguration of its first Governor, Vilém Pospíšil, the then Minister of Finance Karel Engliš said:
'I place in your hands our most precious national treasure, the Czechoslovak crown, a treasure not of gold or silver, but of labour… The stability of our unit of currency, its purchasing power, the first and foremost attribute of every currency, lies in price stability, in stability of the cost of living. Woe betide us if this unit falls… Just as an engineer cannot quietly change technical units, so too the national economy must have a firm and stable unit in order to thrive…"< /p>
Today, 80 years on, we have a great opportunity to look back and see how well this objective was achieved. Despite various changes in fortune over the past 80 years, the Czechoslovak Republic and its two successor states, the Czech Republic and Slovakia, can indeed claim a tradition of price and currency stability.
In this context, let me take you back to the very beginnings of the independent Czechoslovak state and the situation in which the new currency unit - the Czechoslovak crown - took shape. Economic collapse had spread across the entire Central European region following the First World War, resulting in hyperinflationary tendencies. All our neighbours - Germany, Austria, Poland and Hungary - were affected to various extents. The Czechoslovak crown remained an island of stability in this sea of economic and currency instability. As Rudi Dornbusch put it in his 'Monetary Problems of Post-Communism': 'Czechoslovakia stopped inflation before it even started".
Clearly this result did not come on its own or at no cost. The stabilisation measures included separating domestic money circulation from that in other countries by officially stamping all circulating bank notes, establishing a national 'banking office" with strict limits on lending to the state, and introducing temporary forms of foreign exchange regulation and property tax, especially on wartime profits. Minister of Finance Alois Rašín, who stood at the economic policy helm, tried to engineer a return to the pre-war conditions. In the situation, this meant achieving not just stabilisation, but a decrease in the price level and an appreciation of the currency. In today's terminology, we would no doubt call this a form of price level targeting.
These efforts produced results. In 1921 the Czechoslovak currency was quoted at 15.52 crowns to the Swiss franc on average on the Zurich exchange. In 1922 the rate firmed to 6.89 crowns to the Swiss franc, and in the years that followed it stabilised just below this level. The crown appreciation policy - a hard currency policy - was the primary means of achieving a fall in the consumer price level. In 1922 this level decreased by around 40% compared to the 1921 average, and in subsequent years it showed no major swings.
The deflationary policy inevitably hit corporate finances and bank liquidity hard, as well as fostering growth in unemployment and social tension. It also met with conceptual criticism. It was gradually eased and, in 1925, officially replaced by a strategy of currency and price stabilisation. However, in subsequent years the economy undoubtedly profited from the successful struggle with the post-war collapse and the avoidance of hyperinflation. The period leading up to the global economic crisis was a time of prosperity and dynamic growth for the Czech economy, and the internal and external purchasing power of the crown was kept at a stable level. The successful stabilisation also created the right environment for the launch of the National Bank of Czechoslovakia.
The Czechoslovak experience at this time attracted considerable attention from economists and even found its way into the macroeconomic textbooks. It showed that stability can be achieved even in a 'young" democracy and under exceptionally difficult external conditions. But it also demonstrated that the process is not painless and that the costs of stabilisation can be high, especially when institutions and their economic policy measures have not yet acquired the necessary degree of credibility.
With the benefit of hindsight, it is clear that efforts to maintain price and currency stability permeated all subsequent developments to one extent or another - naturally with different results in different conditions. It is worth mentioning that even under central planning this tendency was not entirely stifled. During the switch to the market economy in the early 1990s, the degree of monetary overhang, or repressed inflation, and the level of foreign debt were relatively low, especially compared to some neighbouring countries.
The Czech National Bank and the National Bank of Slovakia - the successor institutions of the former National Bank of Czechoslovakia - have successfully continued the tradition of price and currency stability.
Once the impacts of the liberalisation measures of the early 1990s had subsided, the rate of inflation in the Czech economy fell, reaching single figures in 1994. Since then, except for a short episode of currency turbulence in 1997, we have succeeded in further systematically reducing inflation to very low values. Inflation targeting, which the Czech National Bank introduced in 1998, has proved a reliable framework. Thanks to the low-inflation environment, the interest rate level, too, has reached a level that compares very favourably with the developed world. As you know, our repo rate has recently been repeatedly below the level of the corresponding ECB rate, as is the case at the moment.
The main monetary policy challenge going forward, as I see it, is to maintain the low-inflation environment as a permanent feature of the Czech economy. In line with the logic of this objective, an inflation target was set in 2004 for the period from January 2006 up to euro adoption. This commits us to maintaining annual inflation close to three per cent. We believe that this level meets the needs of a converging economic and simultaneously reflects the demands of future fulfilment of the Maastricht inflation criterion. We see the implementation of this clearly defined and well anchored monetary strategy as our fundamental contribution to desired macroeconomic stability and sustainable economic growth.
The results, facts and experience all justify the claim that price and currency stability has become a characteristic feature of the Czech and Slovak economies. The Czech National Bank and the National Bank of Slovakia are regarded as credible institutions that have successfully continued the tradition established 80 years ago by the National Bank of Czechoslovakia.
The confidence and respect earned by the two central banks through their professionalism and purposeful policy have led to both institutions being entrusted with the task of integrated supervision of the entire financial market. It is, in a way, symbolic that - exactly 80 years on - this key function has been delegated to both successors of the National Bank of Czechoslovakia. In the case of the National Bank of Slovakia the changeover occurred on 1 January 2006 and at the Czech National Bank it happened on 1 April 2006.
Maintaining financial stability is the other core objective of central banks besides price and currency stability. This does not alter the fact that, in contrast to the entirely clear and easily measurable definition of price stability, we do not have such a clear definition of financial stability. It is usually defined as a situation with a well-functioning financial system that effectively mediates relations between creditors and debtors, the implementation of payment flows and the spreading of risks, leading to efficient allocation of resources to particular activities and over time. The second, narrower, approach defines financial stability negatively, namely as a situation where financial instability adversely affects the real economy. This definition reminds us of the high costs incurred in the recent past as a result of financial instability and banking crises in a whole series of advanced and developing countries.
Regardless of which definition we choose, the experience and trends to date clearly convince us of the fundamental importance of financial stability for economic development. In the past we have focused mainly on the banking sector. Over the years the Czech National Bank has succeeded in establishing a quality infrastructure and professional teams with considerable experience of banking supervision. The quality of banks' risk management and control mechanisms has taken centre stage, and the main challenge has been the implementation of the new capital adequacy framework known as Basel II and the related comprehensive assessment of banks' risk profiles.
Although our financial system, like those in other European countries, remains largely bank based, its structure and the weights of its individual segments are evolving. The weight of insurance companies, various funds, leasing companies and other non-banking institutions is growing, the range of financial products and services on offer is expanding, and the individual segments of the financial market are becoming increasingly interlinked. These tendencies have required us to broaden our field of vision from the banking sector to the wider financial market. In recent years, analysis of financial stability, the risks thereto and the resilience of the financial system to shocks has moved to the focus of attention not only of foreign institutions, but also the Czech National Bank. As you know, every year we compile and publish a financial stability report.
The integration of supervision of the entire financial market and its placement in the National Bank of Slovakia and the Czech National Bank comes in response to these trends in the financial market and its structure. We expect the integrated approach to lead to lower costs, more transparent and effective supervision, and more efficient and stable operation of financial markets. All stakeholders should gain, supervisors and regulators as well as supervised and regulated institutions. The merger of the existing 'sectoral" supervisors currently ongoing in the Czech National Bank is merely the catalyst for this process. Indeed, it marks only the start of our efforts to realise the synergistic effects. The economies of scale and more efficient use of existing technical and human resources must be accompanied by harmonisation of procedures, elimination of duplications and gaps and standardisation of supervisory methods across the individual segments of the financial market. We are aware that this is a process and that aligning the standards, procedures and internal cultures of the various regulators will take time and systematic attention on our part. I firmly believe that our work in this area will carry forward the best traditions of the National Bank of Czechoslovakia.