3. The CNB’s monetary policy

The composition of the CNB Bank Board, the process of appointing its members, the length and number of their terms of office and the principles of its decision-making are governed by the Act on the Czech National Bank (Act No. 6/1993 Coll., as amended).

Bank Board members are appointed and relieved from office by the President of the Czech Republic. Any citizen of the Czech Republic who is fully competent to perform legal acts, has completed a university education, is of integrity and is a person of professional experience and recognised standing in monetary matters or in the area of the financial market, may be appointed a member of the Bank Board.

The Governor, or, in his absence, a Deputy Governor nominated by him, chairs the meetings of the Bank Board. The Bank Board acts by a simple majority of the votes cast. It has a quorum if the Governor, or a Deputy Governor nominated by him, and at least three other members of the Bank Board are present. In the event of a tie due to the absence of a member of the Bank Board, the Governor, or a Deputy Governor nominated by him, has the casting vote.

The Governor represents the Czech National Bank externally and signs legal rules and acts issued by the Czech National Bank and promulgated in the Collection of Laws and the Collection of International Agreements. If the office of Governor is unoccupied, the Bank Board authorises one of the Deputy Governors to perform the duties of the Governor until a new Governor is appointed. The authorised Deputy Governor performs the duties of the Governor to the full extent of his powers and responsibilities. From 17 December 1997 to 23 July 1998, the post of authorised Deputy Governor was held by Pavel Kysilka, as the then Governor Josef Tošovský was appointed prime minister of a caretaker government.

The performance of duties of a Bank Board member terminates with the expiration of his term of office or on the day immediately following the day on which written notice of relief from office or of written notice of resignation from office is delivered, or at some later date given in the notice of relief or resignation from office. A Bank Board member may be relieved from office by the President only if he no longer fulfils the conditions required for the performance of his duties or if he has been guilty of serious misconduct.

The current composition of the Bank Board

As a rule, the Bank Board makes monetary policy decisions eight times a year. At each regular meeting, it has at its disposal an internal document entitled the Situation Report on Economic and Monetary Developments, which serves as a key input for its monetary policy decision-making. This document contains a new economic forecast. However, new forecasts are only prepared for the meetings in February, May, August and November, not before every meeting. In these cases, the document is referred to as the Large Situation Report. The situation in the Czech economy does not usually change fast enough to warrant going through the time-consuming forecasting process every six to seven weeks. At the other four meetings, the Situation Report incorporates new data into the existing forecast, evaluates the situation with respect to the possible future course of inflation, and assesses the uncertainties and risks of the outlook for the fulfilment of the inflation target.

In addition to the baseline scenario of the forecast prepared by the Monetary Department, which contains the most likely paths of economic variables, the Bank Board may request the preparation of alternative scenarios or simulations capturing inflationary and anti-inflationary risks to the baseline scenario. These are also included in the Large Situation Report. The forecast and the related risks and uncertainties are complemented by an Inflation and Monetary Policy Risks Scoreboard, which calculates long-term inflationary risks and other potential monetary policy threats and illustrates them using colour scales. The Scoreboard aims to capture phenomena which, being hard to quantify, can be difficult to incorporate into the conventional forecasting system but which may have a potentially significant effect on inflation if they occur simultaneously.

The Situation Report also contains the Monetary Department’s monetary policy recommendation regarding the appropriate monetary policy settings. This recommendation includes not only specific interest rate levels, but also proposals for related communications by the Bank Board members. Forward-looking communication is particularly important under inflation targeting, as it helps to shape financial market participants’ economic expectations. The Bank Board is also provided with opinions drawn up by one of its advisers and by the Financial Stability Department and with numerous other inputs for its monetary policy meetings.

The CNB Bank Board’s monetary policy meeting begins with a presentation given by the Monetary Department. This outlines the macroeconomic forecast described in the Situation Report, the related risks and uncertainties, other monetary policy considerations, and recommendations on interest rates and overall communication. Representatives of the Financial Stability Department, the Financial Markets and Resolution Department and the General Secretariat also attend the meeting.

Based on its assessment of the inflationary and anti-inflationary risks of the baseline scenario of the forecast, the Bank Board may express reservations about the baseline scenario at the monetary policy meeting. If the Bank Board has also asked the Monetary Department to prepare alternative scenarios or simulations of future economic developments, it may express a preference for one of these scenarios, including one involving a different monetary policy response.

The presentation and the first round of questions is followed by the second part of the meeting, at which only the Bank Board and the heads of the above-mentioned units are present. Each Bank Board member expresses their view on the current situation and indicates how they will vote. At the end of the meeting, the Bank Board votes on interest rates and occasionally also on other monetary policy measures.

As soon as the Bank Board makes the interest rate decision at its meeting, the decision is communicated in a press release, which is published on the CNB website that afternoon. The decision is subsequently explained and expanded upon at a press conference, at which the Bank Board’s statement is presented and the ratio of the votes cast on interest rates is released. A live stream of the press conference, the Bank Board’s statement and the accompanying presentation are made publicly available on the CNB website. When the CNB releases a new quarterly forecast (in February, May, August and November), projections of key economic variables (headline inflation, monetary policy-relevant inflation, GDP, the koruna-euro exchange rate and the forecast-consistent interest rate path) are also disclosed at the press conference and on the CNB website on the day of the decision.

The first section of the Monetary Policy Report, summarising the Bank Board’s monetary policy decision, the economic outlook and the related risks, and any thematic boxes and appendices are published a day after the monetary policy meeting. That same day, four times a year, a meeting with financial market analysts is held, at which the CNB Monetary Department’s more detailed view of the current economic situation and the new forecast are presented. A live stream and a recording of the meeting with analysts are posted on the CNB website. The meeting is held in English.

A more detailed account of the discussion leading up to the Bank Board’s decision, including attributed arguments and the votes cast by the individual Bank Board members, is issued eight days later in the minutes of the meeting, which have been published since 2020. The Monetary Policy Report, which contains the CNB’s forecast and a description of the domestic and foreign economic situation, is also published together with the minutes in February, May, August and November. A full transcript of the meeting, the Situation Report, the Monetary Department’s monetary policy recommendations and other opinions are published six years later.

The Monetary Department issues various publications to inform the public about the economic and monetary policy situation in the Czech Republic and around the world.

The Monetary Department’s flagship publication is the Monetary Policy Report. It is published once every quarter and is based on the Situation Report, which is the main input for monetary policy meetings. The Monetary Policy Report opens by summarising the recent monetary policy decisions made by the Bank Board and then presents current economic developments, the economic outlook and the Monetary Department’s forecast. It also usually contains thematic boxes summarising topical monetary policy and economic issues and occasional appendices. A Chartbook is published together with the Monetary Policy Report. It contains charts depicting much of the data evaluated in the monetary policy decision-making process.

Another Monetary Department publication is Central Bank Monitoring, which provides a quarterly overview of the recent monetary policy developments, strategies and communications at eleven central banks, including the CNB. Each issue also features a Spotlight section covering a current topic and a selected speech given by a prominent foreign central banker. The banks monitored are the central banks of the USA, the euro area, the UK, New Zealand, Norway, Switzerland, Canada, Sweden, Hungary and Poland.

The Monetary Department also publishes Global Economic Outlook. Each month, Global Economic Outlook pools information in text and graphical form about the latest predictions and outlooks for economic variables (inflation, GDP, interest rates, the exchange rate, commodity prices, etc.) of international institutions, selected central banks and Consensus Economics for the euro area (and its member countries), Germany, the USA, the UK, Japan, China, Poland, Hungary and Russia. Each issue also analyses a selected topic affecting the world economy or having an academic subtext.

The Balance of Payments Report is issued in early June and analyses the individual items of the Czech Republic’s balance of payments in the previous calendar year. It focuses on the current, capital and financial accounts and their main components, and monitors the Czech Republic’s debt and international investment position. Each issue is complemented by thematic articles of an academic nature. Between individual issues of the report, the latest time series are made available on the balance of payments statistics web page.

In connection with the commitment to adopt the single European currency, the CNB performs detailed analyses once a year, which it publishes in its Analyses of the Czech Republic’s Current Economic Alignment with the Euro Area (the “Alignment Analyses”). This publication analyses the Czech Republic’s economic alignment with the euro area and the ability of the Czech economy to absorb potential asymmetric shocks by means of other mechanisms after losing its own monetary policy. The document also monitors the economic and institutional developments in the European Union and the euro area, and the resulting obligations relating to euro area entry. Thematic chapters make up a substantial part of the Alignment Analyses. They discuss selected important economic issues related to the adoption of the euro in the Czech Republic in more detail. The Alignment Analyses also contain a Chartbook, which presents the outputs of the analyses in charts and tables.

In addition to the above publications, the Monetary Department, together with the Financial Stability Department, prepares the Bank Lending Survey, which provides information on the Czech banking sector obtained by the CNB in a survey conducted four times a year. It sums up where credit standards and terms and conditions for approving loans are heading and how demand for loans among households and corporations is changing. The survey also covers credit market developments expected by commercial banks in the months ahead.

Due to their research work, which is closely bound up with the performance of the CNB’s price and financial stability duties, the Monetary Department’s economists contribute as authors to the CNB Working Papers and CNB Research and Policy Notes series. These publications summarise the results of the CNB’s research projects as well as the other research activities of both the staff of the CNB and collaborating outside contributors. Both research series aim to present original research contributions relevant to central banks and are refereed internationally. The views expressed are those of the authors and do not necessarily reflect the official views of the CNB. The Working Papers series is published in English.

Interest rates are the CNB’s main monetary policy instrument. The Bank Board decides on their settings at its monetary policy meetings. The rates are announced on the CNB website after the end of each meeting.

The main CNB instrument is the two-week (2W) repo rate. Banks can deposit their excess liquidity at the CNB for a two-week period on the basis of repurchase agreements (“repos”) at a rate not exceeding the two-week repo rate. By changing the repo rate, the CNB influences short-term interest rates on the interbank market. This signal then spreads to interest rates throughout the economy, to economic activity and ultimately to inflation.

The CNB usually conducts repo operations three times a week as repo tenders. To reduce the costs of absorbing excess liquidity to a minimum, the CNB usually holds the tenders as American auctions. Liquidity-absorbing repo auctions proceed as follows: The CNB offers commercial banks the option to deposit a certain amount of their surplus liquidity with it, in line with the needs of the banking sector. In exchange, it provides banks with a return. The maximum return corresponds to the upper-limit rate for two-week repo operations. Commercial banks submit bids for both the amount of money they want to deposit with the CNB and the interest rate at which they are willing to deposit the funds. The bids are then progressively satisfied, starting with those with the lowest rate, until the previously announced repo tender amount is reached. However, the rate at which commercial banks deposit their money at the CNB may only be lower than or equal to the upper-limit rate, not higher. Information on the results of current repo tenders can be found on the CNB website. The CNB only accepts and provides certain koruna-denominated securities – mainly CNB bills, T-bills and government bonds – as collateral in its repo operations.

Besides the 2W repo rate, the CNB also declares a Lombard rate and a discount rate. Commercial banks may borrow overnight liquidity from the CNB at the Lombard rate against collateral provided under the lending facility. The Lombard rate is usually one percentage point higher than the 2W repo rate. Banks operating in the Czech Republic have long been sufficiently liquid and thus, with a few brief exceptions, do not use the CNB’s Lombard facility. The discount rate is applied to commercial banks’ liquidity deposited overnight under the central bank’s deposit facility. It is usually one percentage point lower than the 2W repo rate. It thus sets a floor for money market rates. The minimum deposit amount is CZK 10 million and no collateral is required. On the Czech market, however, excess liquidity is predominantly absorbed from the banking market in repos, so banks make minimal use of the deposit facility.

Besides interest rates, the CNB may use interventions in the koruna foreign exchange market as a monetary policy instrument. Since the Czech Republic is a small, open economy, the exchange rate of the koruna has a strong bearing on the economy, as it directly affects prices of imported and exported goods and services and the competitiveness of domestic firms on foreign markets. Until the end of May 1997, the koruna was pegged to a basket of foreign currencies (page available in Czech only). Today, the Czech economy operates under a managed float regime. The exchange rate floats, that is, it is affected by supply and demand in the foreign exchange market. However, the CNB may use extraordinary interventions to prevent excessive fluctuations of the koruna that would jeopardise price stability or financial stability.

Interest rates are usually the central bank’s main instrument. However, the range in which they may be set is limited. If the central bank’s interest rates fall to the effective lower bound and monetary policy needs to be eased further, especially due to persistent deflationary pressure, the central bank must draw on the wide range of unconventional tools at its disposal.

One unconventional monetary policy tool is “forward guidance”. This involves the central bank providing information about its future intentions based on its assessment of future economic developments. For example, if the central bank issues a statement that its key interest rates will remain low in the future, commercial banks will be more likely to set lower interest rates on long-term loans because they will be able to borrow from the central bank at a lower rate if needed. This allows firms and households to obtain cheaper loans for investments and large purchases, which in turn stimulates the economy.

After monetary policy interest rates have been lowered to zero, it is natural to reduce them further into negative territory. By introducing negative interest rates, the central bank penalises commercial banks for holding excess reserves at the central bank. This encourages them to actively manage their liquidity, i.e. to finance more investments. However, there are limits on how far interest rates can fall into negative territory and how long they can stay there. These limits are determined mainly by the need to preserve the stability of the financial system. Rather than boosting consumption, negative rates may prompt households to hoard cash to avoid paying negative interest on their savings.

Quantitative easing involves large-scale purchases of assets (primarily government bonds) by central banks and related growth in central banks’ balance sheets. Such action leads to a decline in long-term interest rates and growth in financial asset prices. This can stimulate spending by households and firms and thus foster a rise in the price level. A similar measure to quantitative easing is qualitative easing. In this case, instead of buying more securities, central banks only change the structure of the securities in their balance sheets – they buy riskier and less liquid assets and sell the high-quality assets they hold. By doing so, they stabilise the market situation, as they give the financial sector the opportunity to transfer riskier assets to the central bank and replace them with more liquid and less risky instruments. This improves the capital adequacy of commercial banks, which are then able to invest more and lend more, again supporting growth in economic activity. Central banks can deploy both types of easing, quantitative and qualitative, at the same time. This change in asset structure amid growth in the central bank’s balance sheet is referred to as credit easing. It has been used, for example, by the US Federal Reserve, the European Central Bank and the Bank of England.

The opposite of quantitative easing is quantitative tightening. During quantitative tightening, the central bank reduces the size of its balance sheet by letting the bonds it has purchased mature and receiving principal payments without reinvesting them in more bonds. Governments usually finance the repayment of these bonds by issuing new bonds. This increases the supply of bonds on the market and hence raises their interest rates. In addition, central banks can speed up the reduction of their balance sheets by selling previously purchased assets before maturity.

Yield curve control is another unconventional tool for easing monetary policy. This again involves central banks buying bonds. However, the main parameter of the purchases is not a set volume, but the achievement of a required decline in yields and long-term interest rates. This supports demand and investment. Yield curve control has been used by the Bank of Japan and the Reserve Bank of Australia, for example.

The CNB’s exchange rate commitment of 2013–2017 was also an unconventional instrument.

The CNB opted for an exchange rate commitment as an unconventional monetary policy instrument in November 2013. It had already cut its key interest rate to technical zero (0.05%) a year earlier, in November 2012. At the same time, the CNB had pledged to keep interest rates at this record low level for as long as needed (forward guidance). It had also announced it was ready to start using the exchange rate as a monetary policy instrument if monetary policy needed to be eased further. To support the economic recovery and avert the risk of deflation, the CNB eventually intervened to weaken the exchange rate in November 2013. It committed to intervene in the foreign exchange market to weaken the koruna and maintain its exchange rate against the euro close to CZK 27/EUR (5–7% weaker than the previous level), but not any stronger. The CNB discontinued its exchange rate commitment in April 2017.

For the Czech Republic, which is a small open economy, a weakening of the koruna is a more effective tool for easing monetary conditions than, for example, credit easing. Unlike in large economies such as the USA, the euro area and the UK, a depreciation passes through very rapidly and strongly to the domestic price level and domestic economic activity via higher import prices. Although the rise in import prices initially causes households’ purchasing power to decline, their demand is redirected towards domestic goods and services. At the same time, the weaker koruna supports Czech exports, increasing firms’ competitiveness and profitability and their willingness to invest. The recovery in production in turn contributes to growth in employment and wages, increasing the purchasing power of households. As a result, aggregate demand and the price level in the economy rise.

Chart – Exchange rate commitment 2013–2017