Monetary and exchange rate policies in the Central and Eastern Europe: lessons and challenges. Jakub Borowski

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1 Monetary and exchange rate policies in the Central and Eastern Europe: lessons and challenges Jakub Borowski Chief Economist Credit Agricole Bank Polska S.A. Building Market Economies in Europe: Lessons and Challenges after 25 Years of Transition 4th Edition of the Annual NBP Conference on The Future of the European Economy in cooperation with the International Monetary Fund 2014 Warsaw, 24 October 2014

2 Successful transition to low inflation amid changing institutional set-up Fixers to floaters: Czech Republic, Hungary, Poland and Romania Fixed (basket) exchange rate (ER) regime as a key tool for initial disinflation Disinflation reconciled with real convergence; transition to explicit Direct Inflation Targeting (DIT) gradual DIT was a successful response to massive capital inflows (EU accession) and outflows in Euro adoption looks far away Fixers forever: Bulgaria, Estonia, Latvia, Lithuania Currency board and fixed ER regime helped borrow anti-inflationary credibility (ER as an anchor) More susceptible to asset bubbles (Baltics) Greater output volatility in the aftermath of global financial crisis though ER regimes remained resilient Euro adoption motivated by both economic and political considerations (exception: Bulgaria) Temporary floater: Slovakia Successful passage through ERM II with implicit DIT and wide fluctuation band (+/- 15%) Passage marked with a bit of luck (large productivity increases amid labour market slack) and a bit of unluck (overvalued conversion rate in 2009) Fixers and floaters: Regardless of the ER regime chosen, medium-term price stability has been achieved (in some countries very recently), reinforced by central bank independence Large external imbalances (especially in Baltics) were not avoided, but ER regimes remained essentially resilient to currency crises 2

3 The case of Poland: global risk aversion as a key driver of exchange rate ,9 4,7 4,5 4,3 4,1 4,0 3,8 3,6 3,4 0 3,2 Jan-04 Jul-05 Jan-07 Jul-08 Jan-10 Jul-11 Jan-13 Jul-14 Spread between NBP and ECB base rates (ppt., lhs) Avarage interest rate on corporate credits (%, lhs) Yield spread between Polish and German 10Y bonds (ppt., lhs) EURPLN (rhs) Source: Reuters 2009: massive PLN depreciation despite rising short-term interest rate disparity : large capital inflow to bond market provides EURPLN stability amid falling short-term interest rate disparity 2014: continous EURPLN stability amid falling short-term interest rate disparity ER channel looks more theoretical rather than effective monetary transmission conduit Czech experience: ER channel can be reactivated under the zero bound 3

4 Direct Inflation Targeting in CE-4: has monetary policy lost its edge? 2,4 Poland 0,4 4,7 Czech Republic 2,2 2,0 0,3 3,7 1,8 1,6 0,2 2,7 1,3 1,2 0,1 1,6 0,9 0,8 0,0 4,5 17,0 Hungary 0,6 0,4 7 0,6 Romania 3,5 14,0 5 0,4 2,5 11,0 1,5 8,0 3 0,2 0,5 5,0 3Y rolling standard deviation of YoY GDP growth rate (lhs) 1 0 Source: Reuters 3Y rolling standard deviation of domestic FX rate against EUR (rhs) 4

5 Conclusions and policy implications ER regimes and their evolution in the CEEC supported successful disinflation Fixers will remain fixers, floaters will remain floaters - corner solutions are strongly preferred ERM II episode in Slovakia enforced by the EU Treaty, otherwise would have been avoided The Japanese-style stagnation in the Eurozone suggests low likelihood of floaters joining the euro soon Over more than a decade, in Czech Republic, Poland and Romania the drop in ER volatility has been accompanied by stable or increasing output volatility Limited ER channel effectiveness suggests a greater interest rate volatility The ER channel effectiveness may be increased under the zero bound The importance of financial stability considerations (risk of asset bubbles) has increased The reduced effectiveness of ER channel suggests lower costs of monetary integration for DIT countries 5

6 Thank you for your attention