Detoxification of the Czech economy or three reasons why we should thank the CNB

The Central Bank (CNB) has twice decided to take action for 20 years. It raised rates by more than a quarter of a percentage point in a single meeting. And to make matters worse, she added that the tightening of monetary policy is not over.

After seven years (the last time this happened at the beginning of interventions), the CNB is once again at the forefront of tabloids.

And even if they are reluctantly or will be borne by real estate agents (cheaper apartments), government politicians (debt financing will become more expensive) or insit macroeconomists from internet discussions (“the CNB will destroy the economy”), I believe that the CNB is doing the best it can do for the Czech economy.

Fixed stability

Even in the conditions of the Czech Republic – and much more so in the Western world – price stability has long been considered a natural and unchanging state of affairs. You must be over 50 in the US and at least 40 in our country to be able to remember the period when inflation was filling the front pages of the local press.

This “immutability” is built on the basis that central banks once sent inflation into eternal exile, which is unfortunately a mistake.

It was not the central banks, but only the coincidence of historical coincidences that ensured unprecedented price stability for one generation of the Western world.

What does precarization mean
Precarisation is a term referring to the replacement of a full employment relationship by another type of link between an employee and an employer. Most often part-time, one-time purchase of a service, agreement on the performance of work or a business relationship. This leads individuals to lose social and financial security in full employment.

Globalization, the Internet, the disintegration of trade unions or the precariousness of labor (for example, the rise of the “custom” (gig) economy in the last decade) have created structural pressure that has kept inflation under wraps. Even in a situation where the negative effects of these trends, especially globalization, on entire sections of the population have been “addressed” by governments by growing public (in Europe) or private (in the US) debt.

And even as this indebtedness began to hit its limits (Maastricht, Greece), there was no clearing: central banks rushed to the aid of governments.

Orgy of ultra-low rates

Interpreting the taming of inflation in the 1990s as their success and the belief in their central bank capabilities, they got the impression that inflation was forever dead. They have materialized the idea that they can circumvent years of economic law and lunches are free. And that losses and volatility no longer belong in economic life.

It was only a short distance from the godly conviction that this was the case for them to start marrying
old orgies of zero or negative real rates. And they began experimenting with unbridled purchases of financial assets, flirting with modern monetary theory, and instead of price and financial stability, they began to address climate and social inequality.

Pandemic factor

The last straw was / is absolutely unprecedented help after the pandemic – however, double-digit annual public deficits and a spurt in the growth rate of the money supply did not excite anyone.

Over the past 15 years, people, politicians and markets have become accustomed to the monetary policy opium of cheap rates and have not noticed that its pandemic dose is already too large.

For years, central banks monetized the debt of their governments and reduced the cost of financing for companies and people, with the result that no one naturally felt any pressure to act responsibly or even to save. And he had no reason to start a pandemic.

But economic laws apply. The endless tensioning of the string has brought about inflation, the real cause of which is demand. We may pretend that the supply side or the broken supply chain is to blamebut this is not the case.

The fact that carmakers do not get simple chips is not the result of broken chains. This is due to the fact that the semiconductor manufacturer prefers to allocate its limited capacity to meet the high demand for its own higher-margin products, rather than to produce chips for a few dollars.

Still the inflation

The fact that transport capacities are occupied does not reflect the greed of carriers or closed ports, but the high demand for containers and goods in them and the lack of staff. Rising commodity prices have less to do with the Green Deal and more with fears that inflation will stick its head out of its alleged grave for decades. And also with the belief that commodities are the way to protect themselves from it.

No, the Chinese aren’t really lagging behind and closing the factory because of the covid – capacity utilization is now even higher than before the pandemic. And even though some members of the CNB’s Bank Board and many politicians are trying to reassure us that we cannot blame for inflation and that this is a problem everywhere, this is not exactly the case:

  • the Czech price level has risen by more than ten percent since the end of 2018 (in the EU at only half the rate),
  • demand inflation in the Czech Republic has risen by 2.5 percent in the last three months (annualized by more than ten percent),
  • in the EU we are almost “worst in inflation” – harmonized demand inflation (HICP) in September it was higher than us (4.3%) only Poland (4.5%). In October, we “dropped” to 3rd place, when Latvia rose to the top.

Inflation is either there or not

But even if these were all one-off factors that disappear once (when?), The accumulation of many one-off factors in an environment of long-term zero or negative real rates, huge deficits and more or less tense labor markets threatens to loosen inflation expectations.

People don’t care if inflation is caused by this or that factor – they only perceive that it is.

In the early 1970s, spending on the Vietnam War and President Johnson’s Great Society program created a mushroom on which inflation rose due to the devaluation of the dollar in 1973 and oil shocks.

Similarly, spending on permanent “aid” to economies after the Great Depression, covered by central bank money, has created a mushroom where inflationary pressures are now rising due to pandemics, international trade stalemates and governments that have lost any fiscal moderation.


MORE ON THE TOPIC:

The CNB is pulling the emergency brake with all its might. Rates fly unexpectedly high

Applause for the central bank for courage. We won’t like it

Inflation as a piece of a complex central bank kit


CNB commands “bed rest”

Although the CNB did not avoid a very loose policy either, errors a experiments with negative effects (for example in the form of an ever-weakening monetary policy exchange rate channel), he is thankfully aware of all of the above.

Our central bankers know that the fact that the Czech economy passed relatively smoothly through the transition of the 1990s was due to the fact that it took place in an inflation-benign period. That price stability is like health – as long as you have it, you overlook it. He begins to realize its value only in a situation when health is lacking. And that lost health is badly regained.

The Czech National Bank knows that the Czech economy is in a state where it has helped to bring about an inflationary illness through excessive activity and supportive means.

In a situation of overheated organisms (labor market) and risky patient behavior (structural deficit at 5-6 percent of potential GDP, the new government, which obviously does not realize the hole in the Czech budget), the consortium of price health guards has no choice. The patient should be prescribed bitter medication and bed rest. It’s good for three reasons.

Three reasons for “treatment”

  1. The slowdown in the economy, or rather the recession that awaits us next year after the tightening of monetary policy, will prevent it from building into inflation expectations and contracts and thus becoming structural.
    We can already see the first signs that inflation is becoming self-propagating. Price clauses in car contracts are nothing more than a consequence of the easing of inflation expectations. Breaking built-in inflation expectations is, as the early 1980s in the United States show, very, very painful. Prevention is unpleasant, but treatment is many times worse and more expensive.
  2. The fact that the CNB wants to return monetary policy to a neutral level, or even to the level of positive real interest rates, is a return to common sense and order.
    The central bank thus ordains a detox economy and forces it to get used to the pernicious habit of low rates. The result is, as with narcotics, a dramatic increase in debt and economic wasting. Just look at how many companies live just because money is free. Of course, detoxification hurts, but life without opium is better and longer than with it.
  3. The Czech National Bank confirms that it is independent, unlike the ECB or the Fed. Their servile behavior towards politicians is just a misguided fact. In contrast, the CNB is confident, independent and assertive.
    The reaction of the members of the Bank Board (to a rather indiscriminate criticism of politicians) was, in my taste, far too mild, but it clearly left the government to the appropriate limits. By raising the rates twice sharply, it is now clear to every politician that the CNB will not let politicians talk about their work.
    This is at least as important as raising rates by two percentage points in October and November to give citizens the impression that inflation will actually be curbed and that the “constant state of inflation” will return.

Leave a Comment