Adam Smith Seminar
The Life with FX Commitment:
Midterm Evaluation and Outlook
Lubomír Lízal, Ph.D.
Adam Smith Seminar Series
Paris
Outline
1.
Situation of the Czech economy in 2013
2.
Passive monetary policy vs. (un)conventional tools
3.
Easing the monetary conditions using FX
4.
Reflection and mid-term evaluation
Outline
1.
Situation of the Czech economy in 2013
2. Passive monetary policy vs. (un)conventional tools
3. Easing the monetary conditions using FX
4. Reflection and mid-term evaluation
5. Summary and outlook
Situation of the Czech economy in 2013: Inflation – actual vs. targets (y/y; %)
•
Inflation was decreasing and was at the lower boundary of the
tolerance band around the CNB’s target (below 1%) at the
end of 2013. In spite of VAT and other tax increases.
Situation of the Czech economy in 2013:
Core inflation – tradables and non-tradables (y/y; %)
• Core inflation negative since 2009.
• For the first time in modern history the growth of prices of
non-tradable goods (and services) stopped. This is very unusual, especially for a converging economy.
• Partly, this was caused by a decline in prices of communication
services. But primarily, it reflected weak demand and slow wage growth. -10 -5 0 5 10 15 20 1/94 1/97 1/00 1/03 1/06 1/09 1/12
Korigovaná inflace bez pohonných hmot (PH) Neobchodovatelné-ostatní
Obchodovatelné-ostatní bez PH Adjusted inflation (except fuels)
Prices of non-tradables (except administered prices) Prices of other tradables (except food and fuels)
Situation of the Czech economy in 2013: Structure of GDP growth (y/y; p.p.)
•
Czech economy back in recession since the beginning of
2012.
•
Net exports had a positive contribution only in 2Q2013.
Fixed investments were negative, change in inventories
-8 -6 -4 -2 0 2 4 6
I/09 I/10 I/11 I/12 I/13
Household consumption Net exports
Gross fixed capital formation Government consumption
• Consistent with the forecast was a significant decline in market interest rates well below zero, followed by a rise in rates above the current levels only at the end of 2014.
• But 2W repo rate lowered to 0.05% on November 1, 2012!
• Given the zero lower bound (ZLB) on interest rates, this pointed to a
significant need to ease monetary policy using other instruments.
Situation in November 2013
Inflation Report IV/2013: Interest rate forecast
(3M PRIBOR in %)
Consistent with the forecast was a significant decline in market interest rates well below zero.
-2 -1 0 1 2 3 4
IV/11 I/12 II III IV I/13 II III IV I/14 II III IV I/15 II
Outline
1. Situation of the Czech economy in 2013
2.
Passive monetary policy vs. (un)conventional tools
3. Easing the monetary conditions using FX
4. Reflection and mid-term evaluation
(Un)conventional monetary policy tools
• Central banks faced the limits of the
standard monetary policy instrument due to long-lasting stagnation.
• Turned their attention to various
unconventional MP measures – negative interest rates, liquidity provision (QE), FX interventions.
• Most economies have been hit by
liquidity crisis and subsequent credit crunch, but Czech financial system has abundance of liquidity.
• Ratio of deposits to loans above EU
average, total deposits exceed total loans.
• Excess liquidity absorbed by the
CNB using repo tenders.
Source: CNB Inflation Reports; ECB
Ratio of deposits to loans granted in selected EU countries
(%; end of 2011; deposits/loans to residents)
0 20 40 60 80 100 120 140 CZ SK PLROBGHU SI LT EE LV BE AT FR IT UKSE DK EA EU
Liquidity ratios over time
(%; QA = quick assets) 100 105 110 115 120 125 130 135 140 20 23 26 29 32 35 03/10 12/10 09/11 06/12 03/13 12/13 QA / assets
Client deposits / loans (rhs) QA / assets (trend)
Monetary policy rates of selected central banks
•
ECB’s deposit facility rate negative since June, 2014.
•
3M Euribor negative since April, 2015.
•
Negative interest rates have recently started to appear in
economies comparable to the Czech Republic later.
-2 -1 0 1 2 3 4 5 6 31. 1. 20 07 30. 4. 20 07 31. 7. 20 07 31. 10. 2007 31. 1. 20 08 30. 4. 20 08 31. 7. 20 08 31. 10. 2008 30. 1. 20 09 30. 4. 20 09 31. 7. 20 09 30. 10. 2009 29. 1. 20 10 30. 4. 20 10 30. 7. 20 10 29. 10. 2010 31. 1. 20 11 29. 4. 20 11 29. 7. 20 11 31. 10. 2011 31. 1. 20 12 30. 4. 20 12 31. 7. 20 12 31. 10. 2012 31. 1. 20 13 30. 4. 20 13 31. 7. 20 13 31. 10. 2013 31. 1. 20 14 30. 4. 20 14 31. 7. 20 14 31. 10. 2014 30. 1. 20 15 30. 4. 20 15 31. 7. 20 15 30. 10. 2015 29. 1. 20 16 Euro area Switzerland Denmark Sweden
ECB shadow policy rates
•
Estimation methods of shadow rates could differ but generally
show much lower values compared to the official policy rate.
•
Changes in shadow rates are important for real interest rate
differential assessment
Source: Benecká, Komárek, Novotný (2015):
3M Euribor Consensus Forecast
•
3M Euribor expected to stay negative in the foreseeable future
due to practically nonexistent inflationary pressures.
•
Impact of positive interest rate differential vis-à-vis the euro on
the koruna exchange rate.
(differences in p.p.) 3M EURIBOR (in %)
-0.5 0.0 0.5 1.0 1.5 -2.0 -1.5 -1.0 -0.5 0.0
Negative rate as (un)conventional monetary policy tool
• In 2008, the CNB introduced liquidity-providing repo operations, but
they were used very rarely.
• Common wisdom in 2013: ZLB is almost binding
• Experience with negative deposit interest rates is still very limited, the
consequences in general very unclear.
• Limited use in 2013, fear of ZLB
• Negative rate does not solve “what-next” issue if limit low reached
• Also potential legal complications with negative rate (penalty interest).
Source: CNB
Monetary policy rates since the start of the financial turbulence (%)
0 1 2 3 4 5 6 03/07 03/08 03/09 03/10 03/11 03/12 03/13 03/14 Euro area US CZ
• Therefore, FX interventions selected
by the Board as the most appropriate MP tool when interest rates hit zero.
• 2W repo rate lowered to 0.05 % on
The Bank Board’s decision of November 2013
•
The Board decided to start using the exchange rate as an
additional instrument for easing the monetary conditions,
stating that: “The CNB will intervene on the FX market to
weaken the koruna so that the exchange rate is close to CZK
27/EUR.”
•
The exchange rate level was chosen to avoid deflation or
long-term undershooting of the inflation target and to speed
up the return to the situation in which the CNB will be able to
use its standard instrument, i.e. interest rates.
•
The exchange rate commitment is one-sided. This means that
the CNB will prevent excessive appreciation of the koruna
exchange rate below CZK 27/EUR. On the weaker side of the
CZK 27/EUR level, the CNB is allowing the exchange rate to
move according to supply and demand on the FX market.
Outline
1. Situation of the Czech economy in 2013
2. Passive monetary policy vs. (un)conventional tools
3.
Easing the monetary conditions using FX
4. Reflection and mid-term evaluation
5. Summary and outlook
0 1 2 3 4 5 6 7 8 9 10 22 24 26 28 30 32 34 36 38 40 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
Development of 2W REPO rate (in %) and CZK/EUR exchange rate
CZK/EUR
2W Repo (right axis)
Interest rate and exchange rate
CZK/EUR rate and the CNB commitment
• After the CNB‘s policy announcement, koruna reached 27 CZK/EUR
quickly, and has been moving at somewhat weaker levels until the middle of 2015.
• The exchange rate volatility decreased significantly (both the actual one,
and implied by futures prices), except for the beginning of 2015.
1/13 4 7 10 1/14 4 7 10 1/15 4 7 10 0 1 2 3 4 5 6 7 8 25 26 27 28 29
CNB’s FX operations and the exchange rate
• Actual interventions were quite massive, but took place only for a
few days after the policy decision of the CNB.
• Client operations amounted to EUR 8.8 bn. since the beginning of
-1 0 1 2 3 4 5 6 7 8 21 23 25 27 29 31 33 35 37 39 1/99 1/00 1/01 1/02 1/03 1/04 1/05 1/06 1/07 1/08 1/09 1/10 1/11 1/12 1/13 1/14 1/15 1/16 Foreign exchange interventions (right axis, EUR bil.) Client operations (right axis, EUR bil.)
Total reserves in USD mil.
• In order to keep koruna above the CZK 27/EUR floor, the CNB had
to start intervening again in July 2015.
Reserves to GDP
• … and relative-to-GDP terms.
Outline
1. Situation of the Czech economy in 2013
2. Passive monetary policy vs. (un)conventional tools
3. Easing the monetary conditions using FX
4.
Reflection and mid-term evaluation
Development since November 2013
•
Almost all key macroeconomic indicators visibly changed in
positive direction – i.e. in accordance with the CNB’s
predictions.
•
Inflation is lower compared to November 2013, but “core”
inflation returned to positive values in 2014 after five years of
Annual percentage changes
Available on 7.11.2013 Q1 2015 Available on 18.2.2016
Gross domestic product (s.a.) II/13 -1.3 I/15 4.0 III/15 4.7 Consumer price index 9/13 1.0 4/15 0.5 1/16 0.6 General unemployment rate (in %, s.a.) 9/13 7.1 4/15 6.0 12/15 4.5 Average nominal wage II/13 1.2 I/15 2.2 III/15 3.8 Number of vacancies 9/13 39,040 4/15 83,700 1/16 107,800 Gross operating surplus of nonfinancial corporations II/13 1.3 I/15 7.5 I-III/15 5.8 Insufficient demand as a limit of production (in %) IV/13 52.0 4/15 44.2 1/16 39.6 Composite confidence indicator (index) 10/13 88.9 4/15 95.1 1/16 98.4
Inflation development
• The decline in fuel prices and administered prices was outweighed
by adjusted inflation excluding fuels and by tax changes; food prices had a neutral effect on average in 2015.
• “Core” inflation returned to positive figures in 2014 after many
years of decline. Now growth in both components.
• Observed development consistent with predicted effects of
exchange rate weakening. Structure of inflation
(annual percentage changes; contributions in percentage points)
-1 0 1 2
1/14 4 7 10 1/15 4 7 10
Adjusted inflation excluding fuels and food Administered prices
Indirect taxes in non-administered prices
Food prices (including alcoholic beverages and tobacco) Fuel prices
Annual consumer price inflation (in per cent)
Adjusted inflation excluding fuels
(annual percentage changes)
-4 -3 -2 -1 0 1 2 1/11 1/12 1/13 1/14 1/15
Adjusted inflation (except fuels)
Prices of non-tradables (except administered prices) Prices of other tradables (except food and fuels)
GDP growth change decomposition
• The Czech Republic among the 10 worst-performing countries of
the EU up to 2013: GDP -1.3% in 2Q 2013. In 2014: GDP +2%, and the Czech Republic moved among the top 10 EU members.
• The change in dynamics of the Czech GDP reached 2.7 pp. in
2014 (from -0.7% in 2013 to 2.0% in 2014).
• Foreign demand + fiscal impulse explain 1.7 pp., the remaining 1
pp. can be attributed to the monetary policy action combined with
-0,7 0,2 1,1 2
Monetary policy + sentiment (+1 pp.)
Fiscal impuls (+1.2 pp.) Foreign demand (+0.5 pp.) Growth in 2014 (+2.0%) Growth in 2013 (-0.7%)
Euro area Consensus Forecast in October 2013 and February 2016
• Strong disinflationary pressures imported from the euro area.
(differences in p.p.) Effective GDP in the euro area (annual % change) (differences in p.p.) Effective CPI in the euro area (y-o-y in %)
(differences in p.p.) Effective PPI in the euro area (y-o-y in %) (differences in p.p.) 3M EURIBOR (in %)
(differences in %) EUR/USD exchange rate (USD/EUR) (differences in %) Price of Brent crude oil (USD/barrel)
-1 0 1 2 3 -0.8 -0.6 -0.4 -0.2 0.0 0.2 0.4
I/13 II III IV I/14 II III IV I/15 II III IV I/16 II III IV Differences CF February 2016 CF October 2013 -0.5 0.0 0.5 1.0 1.5 2.0 -2.3 -2.0 -1.7 -1.4 -1.1 -0.8 -0.5 -0.2 0.1
I/13 II III IV I/14 II III IV I/15 II III IV I/16 II III IV
-4 -3 -2 -1 0 1 2 3 -5.5 -4.5 -3.5 -2.5 -1.5 -0.5 0.5
I/13 II III IV I/14 II III IV I/15 II III IV I/16 II III IV
-0.5 0.0 0.5 1.0 1.5 -2.0 -1.5 -1.0 -0.5 0.0
I/13 II III IV I/14 II III IV I/15 II III IV I/16 II III IV
1.00 1.10 1.20 1.30 1.40 -16 -12 -8 -4 0 4
I/13 II III IV I/14 II III IV I/15 II III IV I/16 II III IV
30 40 50 60 70 80 90 100 110 -70 -60 -50 -40 -30 -20 -10 0 10
Monetary conditions in the Czech Republic
• Real monetary conditions index = 3M PRIBOR market rate
adjusted for inflation expectations + exchange rate component.
• Describes the aggregate monetary policy stance.
• The monetary conditions have been very accommodative since the
end of 2013, albeit rather less so in 2015 as a result of a fall in
Source: CNB IR II/2015
Basic RMCI version
(positive values refer to easy monetary conditions and negative values to tight monetary conditions; source: CNB, CNB
calculation) -0,4 -0,3 -0,2 -0,1 0,0 0,1 0,2 0,3 24 25 26 27 28 29 30 31 32 33
I/04 I/05 I/06 I/07 I/08 I/09 I/10 I/11 I/12 I/13 I/14 I/15
GDP decrease Exchange rate component
Interest rate component CZK/EUR Basic RMCI
Outline
1. Situation of the Czech economy in 2013
2. Passive monetary policy vs. (un)conventional tools
3. Easing the monetary conditions using FX
4.
Reflection and mid-term evaluation
BEGGAR THY NEIGHBOUR?
Real effective exchange rate (2007 = 100%)
• SNB trying to tame the strong appreciation of Swiss franc after the 2008 crisis.
• Real effective exchange rate of CZK appreciated by 10% during the crisis period,
which is equivalent to permanent tightening of monetary policy.
• Counterbalanced by interest rate decreases, but ZLB reached.
• Verbal interventions only have limited effects and work only for limited time.
Source: BIS 50 60 70 80 90 100 110 120 130 140 1/99 1/00 1/01 1/02 1/03 1/04 1/05 1/06 1/07 1/08 1/09 1/10 1/11 1/12 1/13 1/14 1/15 1/16 2007 a ve ra ge = 100
Czech koruna Swiss franc Hungarian forint Polish zloty
Swiss FX commitment
US liquidity crisis
Fall of Lehman Brothers
Czech FX commitment
Nominal interest rates in the Czech economy
•
3M PRIBOR rate (0.3%) remains at historical lows and
reflects the setting of the CNB’s key interest rates at technical
zero.
•
Interest rate on loans to non-financial corporations in nominal
terms followed a decreasing trend in 2015, dropping slightly
below 2% for koruna loans.
Interest rates in the Czech economy
(percentages) 0 1 2 3 4 1/10 1/11 1/12 1/13 1/14 1/15 1/16 2W repo rate 3M PRIBOR
Monetary conditions: What influences investment return?
•
Investment decision-making: Profitability of a project
described by the net present value.
•
NPV takes into account future cash flows and discounts them
using opportunity interest rate, i.e. the expected yield of
projects of the same riskiness.
•
Expected real interest rate has the following components:
1. Expected nominal interest rate
2. Expected inflation rate (with the minus sign)
1.
How to influence the (expected) interest?
By cutting the (nominal) interest rates.
• Easy, if interest rates positive and non-zero.
• If already at the zero lower bound, it is possible to announce interest rate commitment and pledge that the rates will stay at a
How to deliver monetary easing?
2. How to influence the expected inflation?
Inflation targeting policy
• In standard times, nominal interest rates are able to influence expected
inflation. Problems arise at the zero lower bound.
• Alternative tools:
Un-conventional tools such as quantitative easing
• By changing the structure of financial assets in the economy, central
banks are able to influence long-term interest rates and indirectly also expected inflation in the future (Fed, BoE, ECB).
Direct weakening of currency
• The exchange rate component can be used at any time, central bank can
intervene against its own currency without limits.
• Possible to announce FX commitment – pledge to not allow the
strengthening of the currency above a give level for a given time period (CNB).
The CNB’s FX commitment increases inflation expectations, decreases
real interest rates, delivers easing of monetary conditions, and therefore encourages consumption of durable goods and increases investment activity.
650 750 850 950 1050 1150 1250 -100 0 100 200 300 400 500 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 cross-border concept national concept investment (right axis; inverted)
Trade balance surplus and investment (CZK bn.)
• About 60-80% of investment is imported. Yearly nominal
investments between 2008 and 2013 decreased by 140 bn. CZK. Net exports therefore had to improve by about 84-119 bn. CZK (= 140*0.6-140*0.85) solely as a statistical consequence.
• Total trade balance surplus in 2013 was 107 bn. CZK.
• Perceived “good results” of foreign trade caused appreciation
Exports and imports
• As a consequence of increase in investments due to substantially
lowered real interest rate weaker CZK led to larger increase in imports
than exports
opposite effect on net exports than beggar thy neighbour policy
(y/y in %; pp; constant prices; seasonally adjusted data)
-6 -4 -2 0 2 4 6 8 -30 -20 -10 0 10 20 30 40
I/11 I/12 I/13 I/14 I/15
Exports of goods and services Imports of goods and services
Outline
1. Situation of the Czech economy in 2013
2. Passive monetary policy vs. (un)conventional tools
3. Easing the monetary conditions using FX
4. Reflection and mid-term evaluation
Forecasts of inflation, interest rates, and GDP: Then (IR IV/2013) and now (IR I/2016)
• Does it mean that the exchange rate tool doesn’t influence prices?
Headline inflation forecast
(year on year in %)
Headline inflation will increase, hitting the 2% target at the monetary policy horizon and then moving slightly above it
-1 0 1 2 3 4 5 6
I/14 II III IV I/15 II III IV I/16 II III IV I/17 II III 90% 70% 50% 30% confidence interval IR IV/2013 Inflation target Monetary policy horizon
Monetary policy-relevant inflation forecast
(year on year in %)
Monetary policy-relevant inflation will reach the 2% target at the monetary policy horizon
-1 0 1 2 3 4 5 6
I/14 II III IV I/15 II III IV I/16 II III IV I/17 II III 90% 70% 50% 30% confidence interval
Inflation target
Monetary policy horizon
Interest rate forecast
(3M PRIBOR in %)
The forecast expects market interest rates to be flat at their current very low level until the end of 2016; consistent with the forecast is an increase in rates in 2017
0 1 2 3
I/14 II III IV I/15 II III IV I/16 II III IV I/17 II III 90% 70% 50% 30% confidence interval
GDP growth forecast
(annual percentage changes; seasonally adjusted) GDP will slow markedly this year due mainly to a drop in government investment financed from EU funds
-2 0 2 4 6 8 10
I/14 II III IV I/15 II III IV I/16 II III IV I/17 II III 90%
70% 50%
30% confidence interval IR IV/2013
Reminder: 3M Euribor Consensus Forecast
•
3M Euribor expected to stay negative in the foreseeable
future due to practically nonexistent inflationary
pressures.
•
Impact of positive interest rate differential vis-à-vis the
(differences in p.p.) 3M EURIBOR (in %)
-0.5 0.0 0.5 1.0 1.5 -2.0 -1.5 -1.0 -0.5 0.0
Sensitivity scenario: Higher Brent price
•
Low oil price establishes a positive supply shock for the
Czech economy in spite of its anti-inflationary impact.
•
How large a shock? Czech Republic is a net importer of oil
products.
• In 2012 and 2013, when the average price per one barrel of crude oil moved above USD 100, external trade deficit in oil products was between CZK 120 and 130 bn.
• If oil keeps to be sold for about half per barrel over a longer period, we can expect a similar drop in external trade deficit – by approx. CZK 60 bn.
•
This translates to about a one-third increase in trade
surplus (CZK 107 bn. in 2013, CZK 150 bn. in 2014).
Almost the same stimulus for Czech economy as the whole
Oil price: Expectations in 2013 vs. reality
•
Oil price expected to be around 100 USD/barrel but dropped
to 60 USD/barrel by the beginning of 2015 instead.
•
In order to analyze the impact on Czech economy, CNB
constructed a sensitivity scenario with oil price fixed at 100
(differences in %) Price of Brent crude oil (USD/barrel)
30 40 50 60 70 80 90 100 110 -70 -60 -50 -40 -30 -20 -10 0 10
Sensitivity scenario of the February forecast: Higher Brent price
• With oil price around 100 USD/barrel, inflation would be on
average 1 pp. higher in 2015, but the GDP and household consumption growth would be significantly lower.
0 2 4 CPI Inflation (y/y, in %)
I/13 I/14 I/15 I/16
0 1 2
Oil price - baseline Oil price - 100 USD/bl.
-2 0 2 4 GDP Growth (y/y, in %)
I/13 I/14 I/15 I/16
-2 0 2 4 0 2 4 Household Cons. Growth (y/y, in %)
I/13 I/14 I/15 I/16
-0.5 0 0.5 1 1.5 2 -0.4 0 0.4 0.8 Nominal Wage (y/y, in %)
I/13 I/14 I/15 I/16
-2 0 2 4
Real economy: Beveridge curve
•
Improvement in the labor market situation indicated by a shift
of the Beveridge curve in the north-western direction, which
corresponds with the position in the cycle.
•
As a consequence, core inflation should gradually increase,
1/16 1/15 1/06 1/07 1/08 1/09
ECB shadow policy rates once again
• Estimation methods of shadow rates differ but generally show much lower values
compared to the official policy rate.
• Strongly negative shadow rates imply an even larger interest rate differential
between the euro area and Czech Republic
• FX commitment acts also as a transmission channel (and guarantee the
avoidance of the opposite of Cook&Devereux appreciation story)
Midterm evaluation and assessment
• New wisdom about ZLB:
• moderately negative deposit rates possible
• seem to be a useful MP instrument for a short time
• MP space is larger than previously assumed but likely country specific
• but all other questions and risks associated with (high) negative rates remain
• With the expected development of the euro area interest rates and the
ECB’s use of unconventional monetary policy tools, the interest rate differential vis-à-vis the euro can stay sizeable by the time the CNB returns to conventional monetary policy.
• FX commitment in case of ZLB has the power to increase inflation and is
not the beggar thy neighbour policy and mitigates the effect of large interest rate differential while in effect
• Negative interest rates, on the other hand, decrease the differential
Useful tool in current world
Conventional monetary policy can utilize the additional space if needed
Use depends on particular conditions and time,
• On February 4, the Bank Board decided to continue using the
exchange rate as an additional instrument for easing the monetary conditions and confirmed the CNB’s commitment to intervene on the foreign exchange market if needed to weaken the koruna so that the exchange rate of the koruna is kept close to CZK 27 to the euro.
• In line with this, the Czech National Bank still stands ready to
intervene automatically, i.e. without the need for an additional
decision of the Bank Board, and without any time or volume limits.
• The asymmetric nature of this exchange rate commitment, i.e. the
willingness only to intervene against appreciation of the koruna below the announced level, is unchanged.
• According to the forecast, the return to conventional monetary
policy will not result in the exchange rate appreciating sharply to the slightly overvalued level recorded before the CNB started intervening, among other things because the weaker exchange rate of the koruna is in the meantime passing through to the price level and other nominal variables.
• The Bank Board stated that any exchange rate appreciation following the discontinuation of the exchange rate commitment would be dampened, among other things, by hedging of exchange rate risk by exporters during the existence of the commitment, by the closing of koruna positions by financial investors and by
possible CNB interventions to mitigate exchange rate volatility.
• The Bank Board assessed the risks to the forecast at the monetary
policy horizon as being broadly balanced.
• The evolution of oil prices, which have recently seen marked
fluctuations, is a significant source of uncertainty in both directions.
• The Bank Board states that the Czech National Bank will not
discontinue the use of the exchange rate as a monetary policy
instrument before 2017. The Bank Board considers it likely that the commitment will be discontinued in the first half of next year.
• The Bank Board again also discussed the possibility of introducing
negative interest rates in light of the widening of the interest rate
