The smashing success of Czech monetary policy

If we look around the world there has been very few monetary policy success stories from 2008 and onwards. However, there is a success story that unfortunately largely has been untold and that is the success of monetary policy in the Czech Republic after November 2013 when the Czech central bank (CNB) decided to fundamentally to change its operational approach to the conduct of monetary policy.

Until late 2013 the CNB in many way had failed. Effectively interest rates had hit the Zero Lower Bound (ZLB) and the CNB clearly was reluctant to use other instruments to ease monetary policy despite of the fact that inflation consistently since crisis hit in 2008 had been below the CNB’s 2% inflation target and that there clearly was significant slack in the Czech economy.

At the same time nominal GDP had essentially been flat from 2008 until late 2013 and deflation expectations clearly were growing.

However, during 2012-13 a number of CNB board members started to hint that there was a way – indeed many ways – to see monetary policy even with interest rates stuck at zero. During this period – in fact starting around 2010 – I had been arguing  – both in my position at that time as Head of Emerging Markets Research at Danske Bank and on my blog that the CNB could use the exchange rate as an instrument to implement monetary easing to hit the 2% inflation target.

More specifically I argued that the CNB could put a “floor” under EUR/CZK in the same way the Swiss central bank had done with the Swiss franc. In non-technical terms this mean that the CNB should cap any appreciation of the Czech koruna against the euro, but allow for depreciation.

In December 2012 I wrote:

The short version of this is: The Czech economy is in a deflationary trap so the CNB needs to ease monetary policy, but with interest rates basically at zero the CNB needs to use the exchange rate to do this. This basically leaves the CNB with two options.

Either to follow the lead from the Swiss bank bank and put a floor under EUR/CZK or to implement a Singaporean style monetary regime, where the central bank starts using the exchange rate (and communication about future depreciation/appreciation) as the primary monetary policy instrument rather than interest rates.

November 2013 – the floor is announced

Whether or not the CNB listened to me I don’t know, but on November 7 2013 the CNB announced the following:

The Board also decided to start using the exchange rate as an additional instrument for easing the monetary conditions. The CNB will intervene on the FX market to weaken the koruna so that the exchange rate of the koruna against the euro is close to CZK 27/EUR.

This effectively was a 4% devaluation of the koruna and a commitment to curb any appreciation pressures as long as Czech inflation was below the CNB’s 2% inflation target.

Needless to say I was extremely happy with the decision and in a blog post commenting on the decision I wrote among things the following:

…This is probably the most important monetary policy decision in post-communist Czech monetary history.

I have long argued that the CNB should do exactly this. For years the Czech economy has been caught in an quasi-deflationary trap and the CNB has so far been mentally and institutionally unable to ease monetary policy as the CNB has been stuck at the Zero Lower Bound. However, anybody who reads my blog and other Market Monetarists blogs should know that central banks can always ease monetary policy – also when interest rates are close to zero. Said in another way there might be a Zero Lower Bound, but there is no liquidity trap.

…CNB governor Miroslav Singer certainly deserves a lot of praise for this bold move. It has taken him far too long, but he finally got it right in the end. In fact Singer has long wanted to do this – but it has taken some time to convince the majority of CNB board member that this was the right thing to do.

Overall, one can say that Singer is following the advice from Bennett McCallum who in a number of papers over the years have suggested that central banks can use the exchange rate as the key monetary policy instrument when interest rates are at stuck at zero. For my earlier discussion of McCallum’s work see here.

A smashing success 

The development in the Czech economy over the past nearly three years in my view provides a test of Market Monetarist thinking. Hence, MM-thinking led me to argue that there was no liquidity trap and that what the CNB’s announcement would work in the sense it would increase nominal spending growth (NGDP growth) and hence curb deflationary pressures.

So how did it in fact go?

Lets first have a look at the favourite Market Monetarist indicators – Nominal GDP.

Skærmbillede 2016-07-25 kl. 21.52.24

It is pretty hard to miss – before November 2013 NGDP was basically flatlining, but exactly as the “floor” under EUR/CZK was announced NGDP growth took off and within a few quarters had accelerated to just above 5% and NGDP growth has ever since grown steady along a 5% path.

Given the fact that potential real GDP growth in the Czech Republic in my view probably is close to 3% this means that 5% nominal GDP over the cycle will ensure inflation around 2%. Or said in another way – CNB has since November 2013 has got it absolutely right!

But how about inflation?

Skærmbillede 2016-07-25 kl. 21.54.11

If we look at the GDP deflator as our measure of inflation then the picture is more or less the same as for nominal GDP even though inflation had started to pick up already in 2012, but after November 2013 GDP-deflator-inflation for the first time since 2009 rose above 2% and even though inflation has eased somewhat over the past year we have not returned to deflation and with the continued healthy growth rate of NGDP inflation is likely to remain fairly close to 2% going forward.

So it is certainly mission accomplished in nominal terms for the CNB – nominal GDP growth has been stable and GDP deflator has been on a 2% growth path, but what about the real-side of things?

Obviously monetary policy cannot impact real variables such as real GDP growth and unemployment over the long run, but if monetary policy is too tight it will in the short-run – which can turn out to be a fairly long period – lead to a slump in the economy and increased unemployment. This of course is exactly what happened in the period from 2008 to November 2013 as the graph below clearly shows.

Skærmbillede 2016-07-25 kl. 22.07.01

However, the graph also shows that the monetary easing implement after November 2013 has helped push unemployment down significantly in the Czech Republic. Hence, there is no doubt that monetary easing have had a real and large impact in the Czech economy.

Monetary policy is highly potent also at the ZLB

The discussion above in my view clearly shows that there is no “liquidity trap” and that central banks always can ease monetary policy also when interest rates effectively are at the Zero Lower Bound if just central bankers commit themselves to do it as the CNB so forcefully has demonstrated over the past nearly three years.

So once again it is clear that monetary policy in the Czech Republic has been a smashing success over the past three year and CNB governor Miroslav Singer – who stepped down as CNB governor after six years earlier this month – deserves a lot of praise for this policy.

The policy implemented under Singer’s leadership clearly has been hugely positive for the development in the Czech economy over the past three years. However, I think it is equally important to stress that other countries easily could follow CNB’s example or as I wrote in November 2008:

… but I also believe that Miroslav Singer is now demonstrating to his colleagues in the ECB that it is possible to ease monetary policy is at the Zero Lower Bound (the ECB is not even at the ZLB!). In that sense Singer is doing everybody a huge favour by demonstrating this.

I hope other central bankers around the world will be listening.

PS the CNB’s board recently said it plans to maintain the EUR/CZK floor at 27, but expect it to be discontinued mid-2017. Given the fact the Czech NGDP growth has slowed a bit below 5% in recent quarters and that the European economy once again looks fragile and global deflationary pressures remain strong I think the signal of discontinuing the floor is slightly premature. That said I don’t think it would cause a major monetary tightening given the fact that the “fair value” for EUR/CZK probably is fairly close to 27.

PPS CNB still could do a lot of things better. See for example my suggestions from November 2013 or the suggestions I made for the SNB in January 2015. The advice for the SNB also would apply for the CNB.

Laurids Rising ( has provided research support for this blog post.

If you want to hear me speak about these topics or other related topics don’t hesitate to contact my speaker agency Specialist Speakers – e-mail:


Monetary tightening will not solve Mozambique’s problems

I have an op-ed over at Zitamar News.

Opinion: Tighter monetary policy can’t change the fact that Mozambique has become poorer

Mozambique is facing the same situation as many other low-income commodity-exporting countries – the price of its main exports have declined sharply in the past two years. In the case of Mozambique, aluminium in particular.

By definition that means that the country is poorer than it was two years ago. Mozambique has also become poorer due to the suspension of some foreign aid programs and higher food prices due to drought.

There is no way around it and the central bank – Banco De Moçambique – can do little about it as these are all negative supply shocks. However, it is nonetheless facing a dilemma.

As terms-of-trade worsen (export prices drop relative to import prices), Mozambique has two options: either it can accept that this will cause the value of the metical to fall, which in turn pushes inflation up and thereby reduces real incomes to reflect that Mozambique has become poorer – or it can fight the drop in the metical by tightening monetary conditions. This is what it did yesterday when it hiked its key policy rate by 300bp to 17.25%, and tightened reserve requirements.

Read the rest here.


If you want to hear me speak about these topics or other related topics don’t hesitate to contact my speaker agency Specialist Speakers – e-mail:

The Euro – Monetary Strangulation continues (one year on)

Exactly one year ago today I was with the family in the Christensen vacation home in Skåne (Southern Sweden) and posted a blog post titled The Euro – A Monetary Strangulation Mechanism. I wrote that post partly out of frustration that the crisis in the euro once again had re-escalated as Greece fell deeply into political crisis.

One year on the euro zone is once again in crisis – this time the focal point it the Italian banking sector.

So it seems like little has changed over the past year. After nearly eight years of crisis the euro zone has still not really recovered.

In my post a year ago I showed a graph with the growth of real GDP from 2007 to 2015 in 31 different European countries – both countries with floating exchange rates and countries within the euro areas and countries pegged to the euro (Bulgaria and Denmark).

I have updated the graph to include 2016 (IMF forecast).

Monetary Strangulation Summer 2016.jpg

The picture is little changed. In general the floaters (the ‘green’ countries) have done significantly better than the peggers/euro countries (the ‘red’ countries).

That said, I am happy to admit that it looks like we have had some pick-up in growth in the euro zone in the past year – ECB’s quantitative easing has had some positive effect on growth.

However, the ECB is still not doing enough as new headwinds are facing the European economy. Here I particularly want to highlight the fact that the Federal Reserve – wrongly in my view – has moved to tighten monetary conditions over the past year, which in turn is causing a tightening of global monetary conditions.

Second, if we look at the money-multiplier in the euro zone it is clear that it over the past nearly two years have been declining somewhat due in my view to the draconian liquidity (LCR) and capital rules in Basel III, which the EU has pushed to implement fast.

Furthermore, given the increase in banking sector distress in the euro zone recently the euro zone money-multiplier is likely to drop further, which effective will constitute a tightening of monetary conditions. If the ECB does not offset these shocks the euro zone could fall even deeper into a deflationary crisis.  If you are interested in what I think should be done about it have a look here and here.

Concluding, the monetary strangulation in the euro zone continues. Luckily, again this year at this time it is vacation time for the Christensen family so I will try to enjoy life after all.


If you want to hear me speak about these topics or other related topics don’t hesitate to contact my speaker agency Specialist Speakers – e-mail:

The Italian bank crisis – the one graph version

Today I was interviewed by a Danish journalist about the Italian banking crisis (read the interview here). He asked me a very good question that I think is highly relevant for understanding not only the Italian banking crisis, but the Great Recession in general.

The question was: “Lars, why is there an Italian banking crisis – after all they did NOT have a property markets bubble?”

That – my regular readers will realise – made me very happy because I could answer that the crisis had little to do with what happened before 2008 and rather was about monetary policy failure and in the case of the euro zone also why it is not an optimal currency area.

Said, in another way I repeated my view that the Italian banking crisis essentially is a consequence of too weak nominal GDP growth in Italy. As a consequence of Italy’s structural problems the country should have a significantly weaker “lira”, but given the fact that Italy is in the euro area the country instead gets far too tight monetary conditions and consequently since 2008 nominal GDP has fallen massively below the pre-crisis trend.

That is the cause of the sharp rise in non-performing loans and bad debt since 2008. The graph below clearly illustrates that.

Bad debt NGDP Italy.jpg

I think it is pretty clear that had nominal GDP growth not fallen this sharply since 2008 then we wouldn’t be talking about an Italian banking crisis today. There was no Italian “bubble” prior to 2008 and there are no signs that Italian banks have been particularly irresponsible, but even the most conservative banks will get into trouble when nominal GDP drops 25% below the pre-crisis trend.

Therefore, I also don’t think that the “solution” to the crisis is a re-capitalisation of the Italian banks or of the entire European banking sector. Rather the solution is to ensure nominal stability in the euro zone. The best way of doing that would be for the ECB to aggressive increase the money base to ensure 4% NGDP growth in the euro zone (see my recent post on what the ECB in the present situation here and my post from 2012 on a cheap firewall against an escalation of the crisis here.)

A key problem, however, is that the euro zone is not an optimal currency area. In a good recent blog post my friend Marus Nunes rightly argued that there is a “Northern” part of the euro zone where monetary policy broadly speaking is “right” and a “Southern” part, where monetary policy is far too tight. Italy is part of this later group.

This means that the question is whether keeping euro zone nominal demand “on track” is enough to ensure enough NGDP growth in the Southern countries to avoid banking and sovereign debt crisis coming back again and again. Unfortunately the development over the past eight years gives little reason for optimism.

PS There are now also increasing talk about problems in the German banking sector. Given the fact that the German economy has doing quite well compared to most other economies in Europe this is rather incredible. Therefore if we should talk about imprudent banking (due to moral hazard problems) then we might want to point the fingers at the German banks.


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A gameplan for the ECB – it is not complicated

A very good friend of mine asked me what the ECB should do in the present situation where inflation and inflation expectations continues to run well-below the ECB’s inflation target.

Here is my answer – it is what we could call a gameplan for the ECB (it could easily be used by other central banks as well):

1) Stop communicating in the terms of interest rates. Announce a PERMANENT growth rate for the money base. Announce that the growth rate will be stepped up every month or quarter until inflation expectations are at 2% at all relevant time horizons – for example 2y2y swap inflation expectations. At every ECB meeting the permanent money base rate is announced.

2) Control the money base by buying a basket of global AAA-rated govies.

3) Announce a NGDP LEVEL target consistent with the 2% inflation target and announce that the ECB will not let bygones be bygones – meaning if you undershoot the target one year then you should overshoot the following year.

4) Internal forecasting should be given up. Instead only surveys of professional forecasters and market forecasts should be used for policy input. In the reasoning for the money base growth target there should be given only a reference to these forecasts and the ECB should commit itself to set money base targets based on these forecasts and nothing else.

And what could the of EU do?

1) Suspend the implementation of Basell III and other banking regulation that depress the money multiplier and increase demand for safe assets until nominal GDP has grown for at least 4% for 8 quarters in a row.

And maybe also…

2) Suspend the growth and stability pact for now.

I think it is very easy to create inflation and nominal demand. It is all about commitment. Unfortunately the ECB does not have such commitment.

PS this is essentially what I earlier have called a forward-looking McCallum rule – see also a similar suggestion for the Fed here.

Lack of NGDP growth is the real reason for Italy’s banking crisis

Back in April I wrote this:

I hate to say it, but I fear that we are in for a new round of euro zone troubles.

My key concern is that monetary conditions in the euro zone remains far to tight, which among other things is reflected in the continued very low level of inflation expectations in the euro zone. Hence, it is clear that the markets do not expect the ECB to deliver 2% inflation any time soon. As a consequence, nominal GDP growth also remains very weak across the euro zone.

…And Spain is not the only euro zone country with renewed budget concerns. Hence, on Friday Italy’s government cut it growth forecast for 2017 and increased it deficit forecast. Portugal is facing a similar problem – and things surely do not look well in Greece either.

So soon public finances problem with be back on the agenda for the European markets, but it is important to realize that this to a very large extent is a result of overly tighten monetary conditions. As I have said over and over again – Europe’s “debt” crisis is really a nominal GDP crisis. With no nominal GDP growth there is no public revenue growth and public debt ratios will continue to increase.

…So be careful out there – soon with my might be in for euro troubles again.

I think we have moved closer to this “euro spasm” and it is now particularly showing up in the form of worries over the state of the Italian banking sector, which adds to the concerns that the markets already have about the state of Italian public finances.

So while the global financial markets seem to been recovering from the initial shock from the outcome of the United Kingdom’s EU referendum and even though the EU system clearly still is in shock from the ‘Brexit’ decision it is clear that the global financial markets seem to have stabilised after a short-lived spasm.

However, for the EU it is far too early to conclude that we are out of the woods. In fact, Brexit might not be the biggest worry for the EU. Instead the next big worry might be Italy.

Italy – 15 years without growth

Italy is without a doubt one of Europe’s absolute worst performing economies over the past decade and recently fears over the state of the Italian banking sector has yet again resurfaced and in the direct aftermath of the Brexit crisis Italian Prime Minister Matteo Renzi has suggested a major bailout package for the Italian banking sector.

However, such plans would likely be in conflict with EU’s new rules that basically means such bailouts should be financed primarily by depositors and creditors rather than by taxpayers so for now it looks like Renzi cannot get an ok from the EU for a new banking rescue package. That, however, doesn’t change the fact that the Italian banking sector is in serious trouble and Italian bank shares have been more than halved in value this year.

The Italian banking sectors’ trouble has little to do with the Brexit vote. Rather the main reason the Italian banking sector is under water is the same reason why Italian public finances are a mess – lack of economic growth.

Hence, there essentially hasn’t been any recovery in the Italian economy since 2008. In fact, real GDP is today nearly 10% lower than it was at the start of 2008 and even worse – real GDP today is at the same level as 15 years ago! 15 years of no growth – that is the reality of the Italy economy.

And have a look at the nominal GDP growth in Italy:

Skærmbillede 2016-07-07 kl. 14.04.10

In the decade prior to 2008 Italian NGDP grew more or less at a straight line. However, since 2008 actual nominal GDP level has fallen massively short the pre-crisis trend.

There are numerous reasons for Italy’s lack of (both real and nominal) growth. One thing is the fact that Italy is in a currency union – the euro area – in which it should never had become a member. Italy’s deep crisis warrants massive monetary easing – in other words Italy needs a much weaker ‘lira’, but Italy no longer has the lira and as a consequence monetary conditions remains too tight for Italy.

Furthermore, Italy is marred by serious structural problems – for example rigid labour market regulation and negative demographics. As a consequence, the growth outlook remains quite bleak.

And even though growth has picked up slightly over the past year it is hardly impressive and latest round of market turmoil has likely further dented Italian growth and Italy could easily fall into recession again in the coming quarters if the banking trouble escalates.

With no growth is it hard to see both private and public debt levels coming down in any substantial way and as a consequence we are very likely to soon again see renewed worries about both the Italian banking sector and Italian public finances. As consequence the EU’s next headache might very well be Italy.



It is time for BoE to make the 4% NGDP target official

While I do not want to overestimate the effects of Brexit on the UK economy it is clear that last week’s Brexit vote has significantly increased “regime uncertainty” in the UK.

As I earlier have suggested such a spike in regime uncertainty is essentially a negative supply shock, which could turn into a negative demand shock if interest rates are close the the Zero Lower Bound and the central bank is reluctant to undertake quantitative easing.

In the near-term it seems like the biggest risk is not the increase in regime uncertainty itself, but rather the second order effect in the form of a monetary shock (increased money demand and a drop in the natural interest rate below the ZLB).

Furthermore, from a monetary policy perspective there is nothing the central bank – in the case of the UK the Bank of England – can do about a negative supply other than making sure that the nominal interest rate is equal to the natural interest rate.

Therefore, the monetary response to the ‘Brexit shock’ should basically be to ensure that there is not an additional shock from tightening monetary conditions.

So far the signals from the markets have been encouraging 

One of the reasons that I am not overly worried about near to medium-term effects on the UK economy is the signal we are getting from the financial markets – the UK stock markets (denominated in local currency) has fully recovered from the initial shock, market inflation expectations have actually increased and there are no signs of distress in the UK money markets.

That strongly indicates that the initial demand shock is likely to have been more than offset already by an expectation of monetary easing from the Bank of England. Something that BoE governor Mark Carney yesterday confirmed would be the case.

These expectations obviously are reflected in the fact that the pound has dropped sharply and the market now is price in deeper interest rate cuts than before the ‘Brexit shock’.

Looking at the sharp drop in the pound and the increase in the inflation expectations tells us that there has in fact been a negative supply shock. The opposite would have been the case if the shock primarily had been a negative monetary shock (tightening of monetary conditions) – then the pound should have strengthened and inflation should have dropped.

Well done Carney, but lets make it official – BoE should target 4% NGDP growth

So while there might be uncertainty about how big the negative supply shock will be, the market action over the past week strongly indicates that Bank of England is fairly credible and that the markets broadly speaking expect the BoE to ensuring nominal stability.

Hence, so far the Bank of England has done a good job – or rather because BoE was credible before the Brexit shock hit the nominal effects have been rather limited.

But it is not given that BoE automatically will maintain its credibility going forward and I therefore would suggest that the BoE should strengthen its credibility by introducing a 4% Nominal GDP level target (NGDPLT). It would of course be best if the UK government changed BoE’s mandate, but alternatively the BoE could just announce that such target also would ensure the 2% inflation target over the medium term.

In fact there would really not be anything revolutionary about a 4% NGDP level target given what the BoE already has been doing for sometime.

Just take a look at the graph below.


I have earlier suggested that the Federal Reserve de facto since mid-2009 has followed a 4% NGDP level target (even though Yellen seems to have messed that up somewhat).

It seems like the BoE has followed exactly the same rule.  In fact from early 2010 it looks like the BoE – knowingly or unknowingly – has kept NGDP on a rather narrow 4% growth path. This is of course the kind of policy rule Market Monetarists like Scott Sumner, David Beckworth, Marcus Nunes and myself would have suggested.

In fact back in 2011 Scott authored a report – The Case for NGDP Targeting – for the Adam Smith Institute that recommend that the Bank of England should introduce a NGDP level target. Judging from the actual development in UK NGDP the BoE effectively already at that time had started targeting NGDP.

At that time there was also some debate that the UK government should change BoE’s mandate. That unfortunately never happened, but before he was appointed BoE governor expressed some sympathy for the idea.

This is what Mark Carney said in 2012 while he was still Bank of Canada governor:

“.. adopting a nominal GDP (NGDP)-level target could in many respects be more powerful than employing thresholds under flexible inflation targeting. This is because doing so would add “history dependence” to monetary policy. Under NGDP targeting, bygones are not bygones and the central bank is compelled to make up for past misses on the path of nominal GDP.

when policy rates are stuck at the zero lower bound, there could be a more favourable case for NGDP targeting. The exceptional nature of the situation, and the magnitude of the gaps involved, could make such a policy more credible and easier to understand.

Shortly after making these remarks Mark Carney became Bank of England governor.

So once again – why not just do it? 1) The BoE has already effectively had a 4% NGDP level target since 2010, 2) Mark Carney already has expressed sympathy for the idea, 3) Interest rates are already close to the Zero Lower Bound in the UK.

Finally, a 4% NGDP target would be the best ‘insurance policy’ against an adverse supply shock causing a new negative demand shock – something particularly important given the heightened regime uncertainty on the back of the Brexit vote.

No matter the outcome of the referendum the BoE should ease monetary conditions 

If we use the 4% NGDP “target” as a benchmark for what the BoE should do in the present situation then it is clear that monetary easing is warranted and that would also have been the case even if the outcome for the referendum had been “Remain”.

Hence, particularly over the past year actual NGDP have fallen somewhat short of the 4% target path indicating that monetary conditions have become too tight.

I see two main reasons for this.

First of all, the BoE has failed to offset the deflationary/contractionary impact from the tightening of monetary conditions in the US on the back of the Federal Reserve becoming increasingly hawkish. This is by the way also what have led the pound to become somewhat overvalued (which also helps add some flavour the why the pound has dropped so much over the past week).

Second, the BoE seems to have postponed taking any significant monetary action ahead of the EU referendum and as a consequence the BoE has fallen behind the curve.

As a consequence it is clear that the BoE needs to cut its key policy to zero and likely also would need to re-start quantitative easing. However, the need for QE would be reduced significantly if a NGDP level target was introduced now.

Furthermore, it should be noted that given the sharp drop in the value of the pound over the past week we are likely to see some pickup in headline inflation over the next couple of month and even though the BoE should not react to this – even under the present flexible inflation target – it could nonetheless create some confusion regarding the outlook for monetary easing. Such confusion and potential mis-communication would be less likely under a NGDP level targeting regime.

Just do it Carney!

There is massive uncertainty about how UK-EU negotiations will turn out and the two major political parties in the UK have seen a total leadership collapse so there is enough to worry about in regard to economic policy in the UK so at least monetary policy should be the force that provides certainty and stability.

A 4% NGDP level target would ensure such stability so I dare you Mark Carney – just do it. The new Chancellor of the Exchequer can always put it into law later. After all it is just making what the Bank of England has been doing since 2010 official!