He is a challenge for you all.
András Simor is governor of the Hungarian central bank (MNB). Next week he will meet with his colleagues in the MNB’s Monetary Council. They will make announcement on the monetary policy action. Mr. Simor needs your help because he is in a tricky situation.
The MNB’s operates an inflation-targeting regime with a 3% inflation target. It is not a 100% credible and the MNB has a rather unfortunate history of overshooting the inflation target. At the moment inflation continues to be slightly above the inflation target and most forecasts shows that even though inflation is forecasted to come down a bit it will likely stay elevated for some time to come. At the same time Hungarian growth is basically zero and the outlook for the wider European economy is not giving much hope for optimism.
With inflation likely to inch down and growth still very weak some might argue that monetary policy should be eased.
However, there is a reason why Mr. Simor is not likely to do this and that is his worries about the state of the Hungarian financial system. More than half of all household loans are in foreign currency – mostly in Swiss franc. Lately the Hungarian forint has been significantly weakened against the Swiss franc (despite the efforts of the Swiss central bank to stop the strengthening of the franc against the euro) and that is significantly increasing the funding costs for both Hungarian households and companies. Hence, for many the weakening of the forint feels like monetary tightening rather monetary easing and if Mr. Simor was to announce next week that he would be cutting interests to spur growth the funding costs for many households and companies would likely go up rather than down.
Mr. Simor is caught between a rock and a hard. Either he cuts interest rates and allows the forint to weaken further in the hope that can spur growth or he does nothing or even hike interest rates to strengthen the forint and therefore ease the pains of Swiss franc funding households and companies.
Mr. Simor does not have an easy job and unfortunately there is little he can do to make things better. Or maybe you have an idea?
PS The Hungarian government is not intent on helping out Mr. Simor in any way.
PPS When I started this blog I promised be less US centric than the other mainly US based Market Monetarist bloggers – I hope that his post is a reminder that I take that promise serious.
PPPS if you care to know the key policy rate in Hungary is 6%, but as you know interest rates are not really a good indicator of monetary policy “tightness”.
Bob Dobalina
/ October 20, 2011Hungarian government is not intent on helping out Mr. Simor in any way.
OTP’s shareholders might beg to differ.
Lee Kelly
/ October 20, 2011The problem appears to be that no central bank is an island … well, except the Federal Reserve. It’s no surprise that U.S. nominal GDP and world nominal GDP are almost an exact match for the last 100 years. Ultimately, I think it’s all about the supply and demand for money, and the Hungarian central bank should satisfy any excess demand for money. If other central banks do not follow this example, and the Hungarian economy suffers for it, then nothing can be done. But better to have monetary disequilibrium in one rather than two currencies, no? There will be winners and losers, but there always are.
Otherwise, free banking is the answer, here more than ever … but I suppose you were wanting a more realistic proposal.
Farid Elwailly
/ October 20, 2011Mr Simor would have to craft a program to incentivise banks to assume the foreign currency loans in return for forint denominated loans. This may take the form of a direct subsidy to banks covering the currency conversion risk for these particular loans. Households who took advantage of the deal would be immunized from currency movements and this new program would directly weaken the forint and therefore be expansionary. Setting expectations for a weaker forint would have to happen as well.
Lars Christensen
/ October 20, 2011Lee, I actually think we have a kind of Free Banking in a number of Central and Eastern European currencies as lending has happening in foreign currency to a large extent. So the banks does not have direct access to a lender of last resort. As such they function as Free Banks, but Free Banking theory is then challenged. How come that they have extent credits to this extent where the bank’s life are threatened? I think it would be an interesting indirect study to look at why banks have extent loans in foreign currency to they extent they have in Central and Eastern Europe when they do not have access to a lender of last resort. My answer is the expectation of euro adoption and widespread moral hazard. But there might be other theories…