1. Monetary Policy and Business Cycle Lecture X Monetary Policy of the CNB Zdeněk Tůma, Jaromír Hurník

2. Inflation targeting Svensson (2000) characterizes inflation targeting as follows:  explicit numerical inflation target...  that is pursued in the medium run to avoid real instability (for instance in the employment)  the decision framework is in practice 'inflation- forecast targeting‘ (due to the existence of unavoidable lags in the effects of instruments on inflation)  in addition, communication is very explicit...  and policy decisions are consistently motivated with reference to published inflation and GDP forecast

3. Inflation targeting Inflation targeting is not a simplistic strategy:  certain preconditions should be met to introduce IT successfully (but it is important to note that one learns swimming only by jumping into water) Inflation targeting is not a rigid strategy, it is a strategy in motion:  IT needs modifications to reflect new theoretical views and concepts that develop every 3-5 years (think SDGE models)  IT needs modifications to reflect new views on best practices (think transparency)  IT needs modifications to reflect new external challenges (think global low inflation)

4. Inflation Targeting Battini, Kuttner and Laxton (2005) evaluate performance of inflation targeters among emerging market economies and compare them to the non-targeters:  “Inflation targeting appears to have been associated with lower inflation, lower inflation expectations and lower inflation volatility …” (pp.179)  “There have been no visible adverse effects on output …” (pp. 179)  “All this may explain the appeal of this strategy for emerging markets, where poor past inflation records make it more difficult to build credibility …and where the output costs of reducing inflation is imperative for social and political reasons” (pp. 179)

5. Inflation Targeting

6. Inflation Targeting and the CNB Key reasons for introduction of IT in the CR:  necessary to anchor inflation expectations hurt by the currency crisis  M2 unable to fulfil this task  impossible to re-introduce the fixed exchange rate  the success of other inflation targeting countries

7. Inflation Targeting and the CNB Stage 1: Dec 97 - Apr 99  The law: CNB to aim at “price stability”  Definition left to CNB - partial goal independence  Targets for “net inflation” - headline inflation net of regulated prices and indirect taxes  Targets as intervals due to uncertainty in (1) forecasts (2) transmission mechanism  Targets:  for end 1998: 6 % ± 0.5 pp (set in Dec 1997)  for end 2000: 4.5 % ± 1 pp (set in Dec 1997)  for end 1999: 4.5 % ± 0.5 pp (set in Nov 1998)

8. Inflation Targeting and the CNB Stage 2: Apr 99 - Apr 01  Long-Term Monetary-Policy Strategy  Price stability - “net inflation” within 1 - 3 %  to be reached at the end of 2005  to be reached “without excessive fluctuations in economic output”  Targets to be set  in agreement with government  not below 1 - 3 %  20 months in advance (for fiscal purposes)  List of exemptions from the target commitment (“caveats”)  shocks to prices of raw materials  natural disasters, shocks in agriculture  non-fundamental shocks to exch. Rate  Target for end 2001: 3 % ± 1 pp (set in April 2000)

9. Inflation Targeting and the CNB Stage 3: Apr 01 - now  Switch to headline inflation (no longer net inflation)  Targets: continuous band, no longer just end of year  For 2002-2005 a target band descending in a linear way  from January 2002: 3-5 % to Decemeber 2005: 2-4 %  From January 2006 a 3 % point target  with a “tolerance” interval ± 1 %  From January 2010 a 2 % point target  with a “tolerance” interval ± 1 %

10. Inflation Targeting and the CNB

11. Inflation Targeting: A Strategy in Motion CNB updates level of the target (global low inflation, completed transition) CNB is improving transparency over time (faster publishing of minutes, the 2008 and 2009 extensions) CNB is improving the forecasting model (from QPM, used since 2002, to SDGE model)

12. Inflation Targeting: A Strategy in Motion Changes since January 2008:  New inflation target of 2% (± 1%) from January 2010  Publication of votes cast by name from 2008  Publication of interest rate path as fan chart from 2008  Reduction in number of meetings to 8 from 2008 Change since January 2009  Publication of exchange rate path as fan chart from 2009

13. Inflation Forecast Key element = intermediate target  Initial situation and current trends  Likely future developments  What need to be done with interest rates to achieve price stability  What are the implicit risks Requires a System for Forecasting and Policy Analysis  Regular forecasting exercise  Inter-forecast monitoring and analysis

14. FPAS: Elements & Organization Elements  Database  Near-term forecast  Medium-term forecast  Forecasting team Organization  Timing  Meetings  Report (The Policy Document)

15. Forecasting Process Five-week process for the f orecasting team Techniques (Models)  Near-term forecast  Expert-based  Times-series econometrics (partial-equilibrium models)  Medium-term: DGE model The Board considers only one, g3-based forecast  Alternative scenarios

16. Near-Term Forecast The current quarter  up to 1Q (quarterly, monthly) Identification of short-run idiosyncratic shocks Expert judgements  An important role of anecdotal evidence, statistic data’ and econometric methods Lacks an explicit policy analysis

17. Near-Term Forecast One method is risky  NTF is set of methods Univariate models  time series models (ARIMA)  Single-equation models  factor models Multivariate models  VAR, SVAR, VEC, BVAR  simultaneous systems Econometric estimation of parameters

18. Medium-Term Forecast Describes interaction of key macro-variables (inflation, real activity, interest rates) over medium term horizon, from 1Q up to … Based on one core model  Relations are valid over the medium horizon  New Keynesian paradigm (long-run neutrality, nominal stickiness)  Closed system – endogenous (inflation, real activity, exchange rate, interest rate) Provides framework for policy analysis

19. Staffing and Techniques Monetary department  Monetary Policy and Fiscal Analysis Division (19)  Monetary policy  Monetary analysis  Fiscal analysis  Macroeconomic Forecasting Division (16)  Near-term forecast  Core-model team (g3)  Model development  International Economic Analyses Division (11)

20. Staffing and Techniques Near-term forecast team  Three expert areas: inflation, labor market, and national accounts (3 experts + head)  Expert knowledge plus econometrics  Prepared for one-year horizon  Only first quarter of the short-term forecast is included automatically in the core model Core-model team  Database manager and model operators (2 experts + head) Teams form the Macroeconomic Forecasting Division

21. Forecasting team Head of the team  Usually the head of the core model group  Reports to the Monetary Department director Near-term forecast expert Core model operator External sector expert Monetary policy expert  Responsible for write-up of the Policy Document to the Monetary Department director

22. Forecast’s organization Initial conditions (Forecasting team + Department management) Meeting with Bank Board - Initial state First version of the forecast (Forecasting team + Department management) Meeting with Bank Board - Alternatives Final version of the forecast (Forecasting team + Department management) Bank Board Meeting (report and presentation) Post mortem meeting

23. Reporting System Macroeconomic developments are reviewed eight times a year  Situation report (8 reports)  Introduced in the late 1990s  Four ‘big’ reports based on the quarterly forecast  Four in the interim (following publication of GDP data)  Open part of the Board meeting  the forecast & staff policy recommendation  Closed part of the Board meeting  Board makes a decision

24. Reporting System Decision and Minutes of the meeting  Decision published around noon  Press conference (3.30 pm)  Voting Minutes of the meeting published 8 days after the meeting  Voting by names Meeting with professional analysts 8 days after the meeting (Vice-governor, two other Board members and Monetary Department Director)

25. Reporting System Inflation Report  Quarterly  Recent data  Forecast  GDP, Inflation  Interest rate (explicit path)  Exchange rate (explicit path)

26. Reporting System Inflation (y-o-y) Interest rate (3M PRIBOR) Exchange rate (level, CZK/EUR)GDP growth (y-o-y)

27. Thank you for your attention.