QuickTake Q&A: Czechonomics 101, an Easy Way to Monetary EasingBy
As the world’s central banks wrestle with complicated tools to lift consumer prices, policy makers in the Czech Republic have a simple solution: wielding their currency to beat back the threat of deflation. Making use of independence from Europe’s common currency, policy makers started printing koruna to buy euros and dollars in 2013, at one point driving the koruna about 6 percent weaker. The bank has since blocked the currency from strengthening past 27 against the euro to push more money into the economy. It’s bought more than $24 billion worth of foreign currencies with newly created tender.
1. How did we get here?
Like their U.S. and euro-zone counterparts, Czech rate setters effectively ran out of room to lower interest rates after cutting their main cost of borrowing to 0.05 percent -- "technical zero" -- in 2012. When even that looked insufficient to stop inflation from turning negative -- deflation -- the central bank took a page from its Swiss counterpart and capped its currency in November 2013. The Czechs’ top-flight credit rating and steady growth outlook prevented investor flight after the central bank knocked the koruna weaker and slapped a lid on how far the currency can strengthen.
2. Has it worked?
Yes, according to the central bank. While inflation remains well below the bank’s target range of 2 percent plus/minus one percentage point, it hasn’t dipped below zero. Prices rose 0.1 percent compared with a year earlier in June, and policy makers see them edging back to within their goal in 2017. While making imports more expensive, the policy has made exports more competitive and prompted Czechs to buy more goods made at home, which the central bank lauds for driving one of Europe’s fastest growth rates.
3. How much longer will the cap stay?
The central bank wants to avoid having to impose a cap a second time, which could happen if it returns to conventional policy too soon. Still, with price growth seen accelerating at the end of 2016, it’s forecasting that it may be able to remove the cap in mid-2017.
4. What’s the exit strategy?
In short, it’s to learn from the Swiss. Policy makers in Zurich abruptly abandoned their currency cap last year, shocking global markets and stinging investors with billions of dollars in losses. The Czechs want what Miroslav Singer, the former central bank governor who introduced the current system, called “a more predictable and mainly non-volatile exit.” Singer’s replacement, Jiri Rusnok, prefers a one-off departure, vowing with his fellow rate-setters to prevent a wild surge once the bindings come off. That might include interventions to buy foreign currencies or, less likely, introducing negative interest rates.
5. What does it mean for the market?
Foreign investors have shrugged off negative yields and piled into koruna-denominated bonds, doubling their ownership in the past two years. They’re counting on a jump in the currency when the central bank dismantles the cap. The koruna regularly bumps against its 27 crown-per-euro ceiling, suggesting it will immediately strengthen when the cap is lifted. Analysts polled by Bloomberg see the koruna trading at 26.3 at the end of 2018, a gain of less than 3 percent from current levels.
The Reference Shelf
- QuickTake explainers on currency wars, currency pegs and negative interest rates.
- A story on investor dreams of a Czech currency payday.
- Former Governor Miroslav Singer explains how currency cap works.
- A Bank of International Settlements’ paper on unconventional monetary policy.
- An IMF report from July 2016 on Article IV consultation for the Czech Republic.
- A lecture by Swiss National Bank President Thomas Jordan on monetary policy in euro-neighboring countries.