In autumn 2013, the Czech economy was in a miserable state. The last time we saw decent growth was six years ago. After the financial crisis came another recession in 2012, which continued in the following year. The National Bank’s projection showed a slight deflation for the next year, i.e. a drop in average prices – but on the assumption that the Czech National Bank will not do anything about it.
The CNB could not do anything about it in the standard way, i.e. by lowering the interest rate. It was already at 0.05% since November 2012. Governor Singer spent months persuading the rest of the council to resort to an unconventional tool: weakening the crown. But he was outvoted at every meeting. Mojmír Hampl only added decisive approval on November 7, 2013, and the interventions began.
I will admit right away, even as Mojmír’s former adviser, that today in a similar situation I would prefer to do nothing. Mild deflation is no more a violation of price stability than mild inflation. But that’s another story, and I’m in the minority among my colleagues. If the central bank believes that 2 percent inflation is best, it makes perfect sense that it is trying to deliver it. At that time it was also not entirely clear whether something like the deflationary spiral of the 1930s might come.
The interventions were not revolutionary
The weakening of the koruna was supported both in the logic of the inflation target and in the practice of other central banks of developed countries. Although they usually did not touch the exchange rate directly, they inflated their assets in another way: mainly by buying government bonds. However, this was not reasonable in the Czech conditions, as the CNB could suck out the entire market.
The interventions worked like this: everyone who wanted to buy a crown received it at the exchange rate of 27 crowns to the euro. The new korunas were created by colleagues in the banking department of the CNB by clicking on the keyboard. When the koruna was weaker than 27 per euro, interventions did not take place. In total, by April 2017, the CNB had tapped out two trillion new crowns.
Was the money printed or spent? Technically neither. Certainly not the ones spent, because the CNB received euros for them. Whether he makes a profit or a loss on them depends on how he invests them and when he sells them. The two trillion were not even printed, although that is only a formal difference – they were clicked. If they were printed physically and stored in banks, the result would be similar.
Intervention and money printing
And this is precisely where the intervention differs from the purchase of bonds, the so-called quantitative easing: we really clicked out new money. When buying bonds, the central bank only exchanges one form of money (bonds) for another (cash). It’s like changing a thousand to 10 hundred crowns: it’s a little easier to pay with it. On the contrary, completely new crowns are created during interventions, it is not just exchange.
Therefore, interventions have a better chance of doing something about the economy. Quantitative easing appears to have had little effect on inflation and growth. At the same time, inflation and growth is what these policies were supposed to achieve. With the interventions, it was supposed to work like this: the CNB will weaken the koruna, thereby making imports more expensive. A weaker koruna will also help exporters who want to employ more people. A heated economy pushes up wages and ultimately prices.
The last sentence is called the “Phillips curve” in economics. Looking at the data, it’s not clear if this is really causal and working the way central banks want it to. In practice, the weakening of the koruna worked somewhat weaker than the bank had expected. However, 10 years later and a number of econometric studies, there is no doubt that the interventions did indeed eventually increase inflation and a little growth.
Intervention impact research
How do we know that? The interventions were a natural experiment. We can compare our economy with countries that did not have interventions. The so-called the method of synthetic control will allow us to estimate the hypothetical development of the Czech Republic without interventions. There are three such studies, and although the results differ slightly, they all confirm price increases (avoidance of deflation) and a slight recovery of the economy due to interventions.
Thus, the interventions fulfilled their purpose, although not as quickly as the CNB expected in autumn 2013. Moreover, the end of the interventions in April 2017 went unexpectedly smoothly. So, until the pandemic came, we evaluated this “exchange rate commitment” as an almost total victory. I remind you again that this assessment applies to a central bank aiming at two percent inflation, which is, however, completely normal.
The legacy of the interventions was tarnished only by the CNB’s behavior after 2017 and especially 2020. As a by-product of the interventions, the CNB sent more euros than the world’s largest hedge funds. But those euros refused to invest in order to earn long-term, following the example of Singapore and Norway. The result is a massive loss for the CNB (thus ultimately all of us), which has two sources.
Intervention as a Pyrrhic victory
First, if the CNB has the majority of euros deposited de facto in a current account, it cannot compensate for the loss resulting from the strengthening of the koruna. When the koruna strengthens, the koruna value of the euro falls. Second, at higher rates, it has to pay tens of billions quarterly to the banks that deposit the crunched crowns with it. Half of the interest income of Czech banks today comes from here. It is not clear how this idle profit affects banks’ willingness to lend to people and businesses.
The CNB made a fatal mistake in 2021, when it refused to use the gigantic stock of euros in the current account to strengthen the koruna and quickly reduce inflation. This is a wasted opportunity of catastrophic proportions that will go down in the textbooks of central banking. We now know that the CNB does not behave symmetrically towards the inflation target. Downward deviations bother her, high inflation not so much. We saw the consequence last year, we see it this year and we will see it in the years to come.
In a nutshell: the interventions have fulfilled the purpose for which they were launched 10 years ago. However, we have not considered their long-term consequences enough. Perhaps then it would be better to blame the loss of the CNB directly on the people “from the helicopter”. It is not clear how the interventions contributed to inflation in 2021–2023. In any case, thanks to them, the CNB was able to massively strengthen the koruna in 2021 in addition to raising rates. That possibility was overblown, which is also why we have had one of the highest inflation rates in the developed world in recent years.