2018 is a year of many important anniversaries.
For the Czech National Bank, however, the most important is one which most people may be unaware of
– the 20th anniversary of the introduction of inflation targeting in 1998.
Tomáš, why this anniversary?
For a central bank, choosing a monetary regime is a bit like getting married
– it takes away the institution's absolute freedom of action,
but it also gives its monetary policy actions a clear order, structure and direction for the future.
The 20th anniversary is the china wedding, so I think that's something worth commemorating.
Since you've just mentioned the china wedding,
how specifically does the introduction of this regime resemble a wedding?
There are two additional aspects.
First, when you decide to enter into marriage, you do so with the hope that it will last forever.
But it doesn't always work out that way.
It's similar with the monetary regime and the central bank.
The second similarity is that it's naive to think you can find an ideal,
such as a woman with the looks of Claudia Schiffer and the brains of Marie Curie.
If you become fixated on that idea, you'll probably be left on the shelf.
Likewise, the central bank must choose from the available options
rather than dream of something absolutely perfect.
What kind of marriage was the introduction of inflation targeting 20 years ago?
First of all, it was a marriage following a nasty divorce.
The nasty divorce was the currency crisis of May 1997, which ended the previous fixed exchange rate regime.
In fact, it turned out – to use the analogy again –
that fixed rate regimes suffer from a high divorce rate.
We were no exception.
What other options did the CNB consider 20 years ago?
There were two realistic options.
The first was money supply targeting, which was frankly a bride who was already a bit past her prime.
On top of that, she wasn't even offering a solid marriage, but rather a more open relationship,
figuratively speaking, in the sense that it had been shown repeatedly in many countries,
including the Czech Republic, that the relationship between money and inflation was very weak, very loose.
The second option – the bride who ultimately proved more alluring – was inflation targeting.
In what circumstances was the decision on the monetary policy regime made?
It was made in a bit of a hurry.
As a result of the divorce consisting in the May 1997 currency crisis,
the central bank had lost the firm order and anchor for its decisions
and had to start looking very quickly for a new system, a new regime.
We were in fact the first central bank in a post-communist transition country to adopt this regime.
On the one hand it was a marriage of convenience, but on the other it was a rather foolish one.
It was the kind of marriage where family and friends shake their heads
and wonder why these fools are getting married so soon.
They don't know each other properly, they haven't even tried to live together
and they are already getting married.
I must admit I was among the doubters
who thought the switch hadn't been prepared very well and might not work,
as did the entire team of the chief economist at Komerční banka, where I worked at the time.
So why do you think the relationship has lasted 20 years?
I'd say that it has not only lasted, it has matured.
That, I think, is the key to its success.
We have worked constantly on the relationship
and we have achieved the best international standard in terms of how our inflation target is configured.
We have made great progress in monetary policy openness.
We have greatly improved our forecasting tools.
So can we say, 20 years on, that this monetary policy regime has been a success even in worldwide terms?
I think it has been a success.
It even survived the tough test of the global financial and economic crisis
and the subsequent European debt crisis.
We eventually had to adopt an unconventional measure in the form of our exchange rate commitment,
which we discontinued only last year.
This measure was new and relatively unpopular, but it served its purpose in the end.
From a long-term perspective, I think it supported the credibility of the inflation targeting regime
and gave us a good starting position for the years ahead.
Is it true that a country which introduces inflation targeting will never leave it?
It has been true so far.
I said that the fixed exchange rate suffered from a high divorce rate,
but as Berkeley economist Andrew Rose shows in a recent article,
no central bank – apart from Slovakia, which adopted the euro – has ever left inflation targeting.
So the divorce rate is minimal.
Perhaps we could conclude this marriage analogy by considering
what challenges the inflation targeting regime is facing going forward.
The main challenge we have been faced with over the last few years
is finding the right relationship between monetary policy and financial stability.
The links between the two are growing over time,
partly because prices of new property – which are also an important variable for financial stability –
are gaining an increasing weight in inflation.
On the other hand, we try to set the rules of coexistence
such that financial stability is a nice neighbour for monetary policy,
a neighbour who is welcome to come round for dinner from time to time,
but shouldn't be too nosy and start interfering too much in monetary policy decision-making.
Thank you for the interview, Tomáš.
Thank you, too.
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