Monetary policy challenges inside and outside of the euro area

Monday, December 12, 2022, 14:00-15:30 Vienna time (CET)

Ľudovít Ódor, Deputy Governor of the Slovak National Bank
Tomáš Holub, Board Member of the Czech National Bank

Tibor Hlédik, Lead Economist, Joint Vienna Institute


High and growing inflation rates have surprised central banks all over the world in 2022. The initially widespread view among policymakers, that price increases are mainly caused by supply shocks, and are therefore transitory, started to change with the emergence of demand pressures. The war in Ukraine intensified the economic uncertainty and increased government spending. The JVI invited two distinguished central bankers from Slovakia and the Czech Republic to share their insights on this important topic. Ľudovít Ódor and Tomáš Holub first presented the inflation and broader macroeconomic developments in their countries, which was followed by a discussion addressing several policy-relevant issues.

Ľudovít Ódor first provided an overview of the recent trends in global energy markets. Wholesale gas and electricity prices have grown dramatically in advanced economies since March 2021, while retail prices changed considerably less, reflecting efforts by governments to minimize the impact on households and companies. The comparison of inflation rates, including the change in food and energy prices, showed a very heterogeneous picture. In the euro area, inflation differentials have been stemming from differences in price regulation schemes, weights of commodity prices in national price indices, fiscal measures, and methodologies in recording housing prices. High weights of energy and food in the CPI contributed to high inflation in Slovakia. However, price pressures were curbed somewhat by sluggish, backward-looking energy pricing. Nevertheless, price increases have been broad based, including food, services and non-energy industrial goods. The decomposition of inflation surprises is pointing not only to supply shocks, but also to domestic inflation pressures. Cross-country comparisons reveal that the Baltic states, as well as Visegrad countries, have higher inflation rates than the ones implied by corresponding labor cost growth rates. Unlike in the Czech Republic, national monetary policy is not available in Slovakia. Fiscal restraint can reduce the cost and the time frame of bringing inflation back to its long run value consistent with the ECB’s target. Model-based simulation results showed that monetary policy tightening in the eurozone would have only a limited impact on suppressing inflation in Slovakia, and even that would materialize only over a longer time horizon. Regarding future developments, the key indicators to watch are labor market trends, fiscal policy, and energy security.

Tomáš Holub started his presentation with the Czech inflation developments and the responses of the CNB to growing price pressures. Inflation has been well above the target, reaching the highest levels since the beginning of inflation targeting. The CNB, was one of the first central banks to respond to mounting inflationary pressures, initially with a 25 basis point hike, followed by a sequence of bigger tightening steps until June 2022. Czech inflation is broad based and tradable price growth has kept increasing. The growth of non-tradable prices has slowed somewhat, reflecting a cooling residential housing market and a sharp drop of households’ real income. Demand-led inflation pressures, however, are still present in all price categories, except fuel. After analyzing domestic developments, Mr. Holub turned to a comparative analysis of inflation across EU countries. He identified three main factors behind inflation differentials: discrepancies between countries’ business cycle positions, the speed of real convergence and the monetary and fiscal policy stance. He showed that countries with lower unemployment rates experience higher core inflation, implying that domestic cyclical positions explain part of the inflation story. In terms of real convergence, former transition countries have been experiencing the highest non-tradable price growth, which may be partly explained by the Balassa-Samuelson effect. Finally, both fiscal and monetary policy intended to react to the Covid-19 shock in a stabilizing manner, but, with hindsight, the accommodative response of policies might have contributed to soaring inflation.

The ensuing discussion raised many policy-relevant issues. The panelists agreed that the biggest challenge for central banks is to anchor inflation expectations around their institutions’ target. Survey results for the Czech Republic imply that the risk of de-anchoring is not negligible. The situation in the eurozone has been slightly different. Financial market indicators, including five years swap rates, are not indicating significant loss of the credibility of the target. Nevertheless, the distribution of survey-based inflation expectations is much wider than in the past. In the discussion on future policy steps needed to restore price stability both policymakers agreed that further interest rate hikes will be needed. The fast stabilization of inflation around the target would send a strong signal to economic agents and mitigate the risk of an inflation-wage spiral in the future. 

Tibor Hlédik, Lead Economist, JVI


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