Author: Marek Pielach

Journalist at Obserwator Finansowy

Czech Republic still has time for monetary policy normalization

We need a new model of economic growth to achieve the full convergence, says Zdeněk Tůma, the former governor of the Czech National Bank.
Czech Republic still has time for monetary policy normalization

(Marek Pielach, public domain)

CE Financial Observer: The cycle of monetary policy tightening in the United States began much earlier than in other developed nations. When will the countries of Central and Southeast Europe (CSE) start raising their interest rates as well?

Zdeněk Tůma: That’s a good but difficult question. Today, it is obvious that many countries are returning to decent economic growth and unemployment is relatively low, not only in the countries of Western Europe, but also in our region. It is therefore natural to ask about the time for reaching normal interest rate levels and the pace of this tightening. The Czech National Bank has already started this process, raising the rate by 25 basis points, and the markets are expecting one more rate hike by the end of this year.

Is this the beginning of a cycle of increases in the Czech Republic?

That’s how it seems. A member of the board of the Czech National Bank gave an interview recently, from which it is apparent that he would like to quickly raise the rates after many years with law rates, not only in the Czech Republic, but also in the Eurozone. I agree that this situation was far from balanced. I don’t want to state, for example, that we have a bubble in the real estate market, but we’ve certainly seen relatively high price increases.

Of course in the Czech Republic we have an independent monetary policy and we do not have to look at the decisions of the European Central Bank, but on the other hand, our economic ties are so strong that we cannot completely ignore them. This is undoubtedly a challenge not only for the Czech Republic, but also for most countries of our region: to find the right pace of interest rates increases.

What will happen if they increase too quickly?

In the Czech Republic we cannot be much faster than the European Central Bank. If we did that, this could lead to an excessively quick appreciation of the CZK and a tightening of monetary conditions that could be harmful for the economy.

Maybe the slow tightening of monetary policy in the countries of our region should be accompanied by a more relaxed fiscal policy?

I don’t see such a need, at least in the Czech Republic. Our economy is currently in the expansion phase, it’s probably growing above its potential, and in such conditions it does not make sense to loosen the fiscal policy. Rather than doing that, this is a time when we should strive for a balanced budget, and even a counter-cyclical surplus. Therefore, both the fiscal and the monetary policy should now be tightened.

Another challenge discussed in our region is the so-called „middle income trap”. In your opinion, does it really exist, and if so, has the Czech Republic already managed to escape it?

We certainly haven’t escaped it. We are still stuck at around 60 per cent of the potential of the German economy. And we see that we are not the only ones. Spain and Portugal were in this situation as well, so it certainly is true that easy convergence only occurs up to a certain point, and then it usually stops. I think that we need a new model of economic growth.

My explanation is that in recent years, when the Czech economy grew very quickly, even at a rate of 5-6 per cent per year, this was the result of productivity growth due to the influx of foreign capital and know-how. And it seems to me that this source of productivity growth has been exhausted, so we need to switch to a different kind of growth, one that is based on innovation.

How can that be achieved?

Politicians have been discussing this issue for years, but for now we don’t see any breakthroughs. We have a problem with adapting our workforce, with infrastructure, with the e-state. Additionally, we can see that the inflow of foreign capital has slowed down. It seems to me that there are no simple solutions here and that the future growth in the Czech Republic will be lower than before, probably below 4 per cent and not above 5 per cent as in the previous years.

Will we have a problem with labor costs? For example, salaries in Hungary are increasing at a double-digit pace, and for now we don’t see any wage pressure. How can we explain that?

I don’t know the situation in Hungary, so it’s difficult for me to comment. In the Czech Republic we are seeing some wage pressure, but that has been a more recent development. We should keep in mind that in 2008 we had to deal with a real economic crisis. After such a crisis, even if there are some wage increases, they are very cautious on the part of the employers. Meanwhile, the wage pressure in the Czech Republic stems from the fact that the solid growth rate in our country began in 2013-2014, and this year we have the lowest unemployment rate in history and a labor shortage. The answer to this is the wage increases.

I’m wondering whether the Czech National Bank will have enough tools during the next global recession and whether, in addition to pegging the exchange rate of the CZK to EUR, it will also be necessary to employ farther-reaching measures, e.g. quantitative easing?

The argument against quantitative easing in the Czech Republic was that we had no liquidity problems. And while in the Eurozone such policies were implemented in order to provide liquidity to the system, in our country they could have had the opposite effect. This is why the Czech National Bank opted against quantitative easing in these critical years. This was probably the right decision also because of the respect for the open nature of our economy.

If there is another crisis, it’s probably not going to happen tomorrow, so I believe that we will have the time to normalize the monetary policy, to raise the interest rates, in order to have some room for their reduction when that is necessary. At the moment the tools of the central bank are indeed quite limited, but I have to repeat: the base scenario assumes that there will be time for the normalization of the monetary policy and that we will have more tools at our disposal.

Zdeněk Tůma – KPMG Partner in Prague, former Governor of the Czech National Bank (2000-2010). Zdeněk Tůma was a panelist during the 7th Annual NBP Conference on the Future of the European Economy.

(Marek Pielach, public domain)

Otwarta licencja


Tags


Related articles

How can monetary policy be made more efficient?

Category: Macroeconomics
The past decade has taught the central banking community the important lesson that negative shocks can happen more frequently, and the time between the shocks may not be long enough to let central banks regain policy space.
How can monetary policy be made more efficient?

Tydzień w gospodarce

Category: Trendy gospodarcze
Przegląd wydarzeń gospodarczych ubiegłego tygodnia (30.05–03.06.2022) – źródło: dignitynews.eu
Tydzień w gospodarce