Interview of Aleš Michl, Bank Board member
Vojtěch Wolf, Martin Petříček
(ekonom.cz, 26 May 2022, Interviews section)
Aleš Michl will be the new Governor of the Czech National Bank from July. After his appointment, the koruna weakened and the CNB had to intervene. According to Michl, however, it was just down do speculators getting jumpy, as they had been expecting rate hikes. “Currency traders on the foreign exchange market got the impression that rates may not go as high as they had expected, which is why the koruna weakened. If I had said rates would continue to rise rapidly, the koruna would have strengthened,” says Michl in his first interview after his appointment as Governor. He wants a strong koruna, but without it being “propped up” by interest rates. “The koruna will only be strong again if we have balanced public finances in the long term. And if our exports are strong and we have a trade surplus, and at the same time the current account does not deteriorate. The Czech Republic doesn’t meet any of this at the moment,” he says.
The koruna weakened sharply after your appointment. This was the first time it has reacted like that to such an event. How do you feel about that?
The exchange rate of the koruna is affected by speculative and long-term flows of money. These were speculative flows. I said upon my appointment: Let’s assume that in July interest rates will be at a certain level and will have a preventive effect against demand inflation. I will recommend at the first Bank Board meeting in the summer in my new role as Governor that interest rates are kept stable for a while, and that we evaluate the new indicators from the economy. And then together we will decide what to do next. Currency traders on the foreign exchange market got the impression that rates may not go as high as they had expected, which is why the koruna weakened. If I had said rates would continue to rise rapidly, the koruna would have strengthened.
However, the CNB subsequently intervened against the weakening of the exchange rate. Did you raise your hand for this extraordinary measure?
I can’t answer that because – unlike at the standard currency meetings on interest rate settings – in this case, we don’t disclose who voted how.
However, your colleague from the Bank Board Tomáš Holub says openly that he was in favour.
I don’t think it’s right to say it. We must respect the rules on informing the financial markets and the public that are set clearly in advance.
Are you worried that the koruna will have a tendency to weaken further with Aleš Michl at the helm of the CNB?
I want a strong koruna based on long-term cash flows into the country and investor interest in the Czech Republic. The koruna has not been following an appreciation trend since 2008. People only evaluate short-term fluctuations, but they don’t see this substantial change. The koruna will only be strong if we have balanced public finances in the long term. And if our exports are strong and we have a trade balance surplus, and at the same time the current account does not deteriorate. The Czech Republic doesn’t meet any of this at the moment.
How do you explain this change in trend?
It may be due to a change in the structure of the Czech economy. We have switched from exports and foreign direct investment inflows to consumption and debt. This needs to be changed, which is why I subscribe to Rašín’s “work and save” motto.
So, raising interest rates doesn’t make sense?
A further forceful rise in rates makes sense only in the event of impending high demand inflation. But currently two-thirds of our inflation is cost-driven, imported – we are unable to lower the price of electricity, gas and petrol by raising rates.
However, some of the Bank Board members and other experts say that a significant rise in rates could dampen inflation.
Taming this type of inflation and the risks it poses for the future requires more than a change in rates, and the media debate has been narrowed down to this one issue. Cost inflation will simply fly through the economy, and no one in the world can do anything about it. The Czech National Bank should communicate it as an exemption from fulfilling the inflation target. The key is to avoid this turning into demand inflation. We can take steps to prevent this from happening.
What steps?
First, it is necessary to keep rates at a higher level than normal. Second, it will also be necessary to reduce the pace at which our country’s debt is rising. And we need to support the government in its efforts. Less debt equals a further slowdown in the growth of money in the economy, which means lower inflation in the future. Third, it is important not to increase wages at a pace exceeding labour productivity growth.
We’re not at risk of a Turkish scenario
However, some are of the opinion that without further rate growth, there will be a Turkish scenario in the Czech Republic, inflation in tens of percent. Is that not a threat?
From an expert point of view, a Turkish scenario in the Czech Republic is an unacceptable comparison. According to the International Monetary Fund, Turkey has a non-transparent budget. Credit growth rates are incomparably higher in Turkey, with the money supply growing by 60% year on year. Major commercial banks owned by the state greatly influence this.
So, a completely different economy. But this probably won’t do much to reassure savers in the Czech Republic.
I realise that people will want to see the results. I will be at the helm of the Bank Board from July. At that time, inflation in our country will probably still be at record highs, around 15%, maybe more. The goal will be to gradually return inflation to 2%.
How long will that take?
I assume it will take two years. The three basic steps required to achieve this goal must take place simultaneously.
Last autumn, however, you argued that maintaining price stability was the task of the CNB and not of the government. And now you’re shifting the responsibility to the government. What has changed in that time?
Maintaining price stability is the task of the central bank. This still holds true. However, this type of inflation requires the coordination of monetary and fiscal policy, so I would like to meet with Prime Minister Petr Fiala. With each further increase in rates, the financing of government debt becomes more expensive, making the government’s position more difficult in terms of reducing the deficit, which is condition number two for reducing inflation.
Should the deficit have been reduced earlier? The initial shock dissipated in the second year of the pandemic if not before that. Production had resumed, people had started shopping. In other words, did Andrej Babiš’s government spend too much in the second year?
Let the voters be the judge of that. As for spending too much, neither Covid nor any other crisis should lead us back to socialism, a situation in which everyone wants support and they use up resources and waste them because they don’t take into account productivity and the quality of outputs. Otherwise, we will not be able to stabilise debt and slow inflation. There is no easier way.
At the beginning of the pandemic, you started compiling the Rushin economic activity index which, based on a number of indicators, seeks to capture the state of the economy before the official data comes in. It is currently signalling a decline of 0.3% in the economy compared with the previous quarter. Will the government not just make the recession worse if it cuts spending?
Yes, that is a risk. A tightening of policies by the CNB and the government will further slow the economy. There’s always a trade-off in economics. However, inflation will fall as a result of these steps. I admit that it’s easier for me to say this as a central banker because I have a great advantage over the Prime Minister: I don’t need to win the next election. I realise people probably won’t like me, and me being strict will annoy them.
Is there any point in tightening policy, even at the cost of a possible fall into recession?
There is point in lowering inflation, because it’s our statutory objective, but at the same time, we shouldn’t cause the destruction of the economy. Otherwise, we’ll end up having to contend with deflation again in a few years’ time. Paradoxically, central bankers wanted to trigger inflation between 2013 and 2017. Now we’re surprised and want to suppress it quickly again. I think it’s better to have a consistent longer-term approach.
Is it already certain that an economic downturn is unavoidable?
All I know is that I don’t know.
You mentioned Rašín’s “work and save” motto, which you often repeat on different occasions. But how do you want to make today’s consumer society give up its comforts and standard of living?
All the major changes in the economy in the past have been preceded by unpredictable events. Rather than predicting another devastating event, it is much easier to switch to the approach that a country, nation, population, entrepreneurs or firms, can better mitigate the effects of disasters if they have savings and wealth in better times and not a pile of debt. These savings are useful right now because there’s nothing I can do in my position but call on the state and businesses to hold back in raising wages and salaries. And the CNB should set an example.
But employee wage growth at the CNB is linked to inflation, with two and a half percent on top of that.
I would like to discuss this on my first day in office with CNB trade union leaders. We have a good relationship. It is our fault, that of the management of the bank, not the fault of the unions or our employees, that we have approved this in the past. I’d like to change that. In a year when the salaries of constitutional officials have been frozen, I find it inappropriate to raise salaries and bonuses even by five percent, let alone inflation plus two and a half percent on top of that.
That sounds a bit like advice from on high. As a well-paid banker, you preach that at 15% inflation, wages should rise by no more than 5%.
But my job is to reduce inflation.
Many economists talk about government restraint. But they add that it is also necessary to raise rates.
I read an article by Professor Václav Klaus entitled “The tortuous dilemma of the new CNB Governor.” He would raise rates further and dampen demand. He says inflation cannot exist without an excess of demand over supply. I would argue with him as regards the logic of deriving a monetary policy response. In his article, Professor Klaus did not consider the new data which show that the growth of money in the economy is already slowing year on year. In addition, most of this inflation was not caused by a sharp rise in demand compared with the pre-Covid level, but because supply fell and prices increased. That led to cost inflation. That’s why I propose rate stability – President Miloš Zeman also spoke in a similar vein in his speech, and economist Petr Bartoň, whom he quoted, also talks about it. Professor Martin Mandel of the University of Economics and my colleague on the Bank Board Oldřich Dědek also take the same view. The impacts need to be assessed. And then we’ll see what to do next.
The CNB can also influence inflation through foreign exchange interventions. Would that be a possible route?
The Bank Board decided not to allow a longer-term weakening of the koruna in a situation of high inflation. Nothing has changed there.
Professor Tomáš Havránek, who served as your adviser, claims that inflation targeting is outdated. What do you think about that?
With due respect to Professor Havránek, I support inflation targeting. The Czech National Bank will remain a conservative institution which is to maintain price and financial stability for the people. These goals will not change in any way in the next six years. I’ll bring evolution, not revolution.
During your appointment at Prague Castle, you outlined how you want to proceed in August. Wasn’t this premature; shouldn’t you make decisions based on current macroeconomic data?
Don’t forget I mentioned the essential assumptions for rate stability in that speech. I said let’s assume that in July interest rates will be at a certain level and will have a preventive effect against demand inflation. If the assumptions are not met, we will respond appropriately after the agreement of the Bank Board.
Nonetheless, you voted to keep rates stable at all the recent meetings.
Professor Oldřich Dědek and I were mainly against dramatic, sharp interest rate increases as a response to cost inflation. Therefore, we at least tried to propose stability.
It seems a bit that you don’t believe much in the forecasts presented to the Bank Board by the Monetary Department. Are you worried that experts will leave the bank because of your appointment?
The Monetary Department’s forecasts are an important basis for our decision-making. The same holds true of inputs from the Financial Stability Department. However, the responsibility for setting rates lies with the Bank Board. My current view on rate settings is broadly in line with the Monetary Department’s simulation published in the latest Monetary Policy Report. As far as this department is concerned, I appreciate its analyses, research and other outputs. I value its work and I will be happy to continue our cooperation in this way.
Other governors came under fire too
How do you explain the huge polarisation in the media and among politicians and experts that emerged after your appointment?
The Governor is appointed by the President of the Czech Republic every six years, and each one of them has “come under fire”. The appointment of Governor Zdeněk Tůma was taken before the Constitutional Court. Governor Miroslav Singer “came under fire” when the currency was devalued, and to this day many people can’t stand him. Governor Jiří Rusnok, whom, by the way, I’d like to thank for his cooperation, ends his term with the highest inflation in history. All that gives rise to emotions. And nowadays everything is more visible due to social media.
Jiří Rusnok was given the opportunity to choose his colleagues on the Bank Board. Were you given that opportunity too? Whom did you suggest?
I am not going to disclose any information from a behind-closed-doors, one-to-one meeting with the President. Never.
There may be up to three new members on the Bank Board from July. Should they be business people, or rather traditional macroeconomists?
The new names are decided by the President; that’s all I can say.
As a member of the Bank Board, you were opposed to the majority opinion, you acted as a rebel. Will this approach change when you’re at the helm of the bank?
The fact that Professor Dědek and I had a different professional opinion than the others does not constitute a rebellion; it is part of a legitimate discussion. Two years ago in May, I said: let’s not lower rates all the way to 0.25%, and let’s not even think about zero. Even then, I was in the minority. From the point of view of current inflation, my opinion was correct. But I respected the majority’s decision, and I will continue to do so. My contribution as Governor will be to seek consensus and compromise.
You have repeatedly said that the CNB should change the way it uses international reserves, which have swelled over the past few years. What do you mean by that?
The reserve management team are professionals; they have been assigned a task by the Bank Board which they fulfil perfectly. I’d like to give them a new assignment and slightly increase the expected return on reserves. This requires more shares and more gold. And I’d like to do so gradually, one step at a time. This involves a change of strategy that takes years. As far as shares are concerned, we buy large companies that have a high weight on the stock market in terms of turnover and market capitalisation, and we hold all the stocks from the best-known indices in the most advanced markets.
Why should a central bank invest its international reserves in this way? Isn’t that a big risk?
Yes, return volatility would then be higher – that’s the risk. However, the expected return would also be higher in the long term. My colleagues Michal Škoda and Tomáš Adam from the CNB and I are trying to calculate this risk as part of a research project. My vision is that the CNB should be profitable in the long term. We’re currently recording a big loss. I would like to set up a strategy so that in the long term the expected return on assets, i.e. international reserves, exceeds the cost of the central bank’s liabilities, which are mainly the deposits of banks that we have to remunerate. Up to now, the balance sheet and the profit and loss account of the central bank have been unimportant, but they are important to me.
Why?
It is a vision to create the wealth of the nation that goes beyond my six-year mandate. Our current loss is someone else’s profit. For example, this year we will pay banks over CZK 130 billion in interest on their deposits in the form of CNB costs.
In its forecasts, the central bank expects a long-term natural appreciation of the koruna thanks to the convergence of the economy towards Western Europe. This could jeopardise returns on international reserves.
As I said, the koruna’s appreciation trend halted in 2008. I will be glad if it resumes. In this case, my concept of the bank’s long-term profitability will extend to the fact that the expected return on international reserves must exceed not only the CNB’s interest costs paid to banks on excess liquidity, but also the potential exchange rate losses from the strengthening of the koruna. Hence, the change in strategy.
How should the shares of the individual components evolve?
I will propose at our Assets and Liabilities Management Committee meeting a gradual increase in the proportion of shares from the current 16% of reserves to 20% or more over a number of years. The central banks of Switzerland and Israel, or large sovereign funds led by Norway, have a similar approach. And we should have more gold, up from 11 tonnes to 100 tonnes or more. Again, gradually over a number of years. Gold is good for diversification; it has zero correlation with shares.
What should happen to the profit?
The Act on the CNB makes this clear. I quote: The Czech National Bank shall defray the costs of its operations from its income. The profit it generates shall be used to replenish its reserve fund and other funds created from profits and for other purposes in the budgeted amount. It shall transfer the remaining profit to the state budget.
But will it not support government spending if the CNB’s profits are sent to the state?
Clear rules should be set in advance. You can choose the Swiss or German model – a kind of dividend for the state. For example, it would be agreed, in accordance with the law, that as soon as we have filled our reserve fund, any additional profit would be transferred to the state budget. The Swiss central bank paid four billion francs, the equivalent of CZK 94 billion, to the state budget and to the canton budgets in the crisis year of 2020. That same year, the German Bundesbank transferred part of its profit amounting to EUR 5.85 billion (CZK 150 billion) to the state budget.
Have you made any calculations as to how much it would amount to in the case of the Czech Republic?
The 153 billion euros of our international reserves at the end of 2021 was CZK 3,811 billion. If, for example, it was possible over the next hundred years to earn an average of 5% or more a year on them and the CNB was profitable, then the dividend could be used to finance the pension system deficit. It is my strategy to start building the nation’s wealth. On average, the annual dividend could be over CZK 100 billion a year. But again, all this is a vision – the current priority is to reduce inflation.
You refer repeatedly to the first Minister of Finance Alois Rašín. What impresses you about him?
I admire his attitudes to life. Together with his great-granddaughter Karolina Breitenmoser-Stransky and other economists, we founded the Association for the Construction of Rašín’s Statue in Prague.
But many people at that time saw Rašín as an enemy because of the decline in their standard of living. And in the end, he was assassinated.
That’s a terrible tragedy.
But is it still possible to apply the approach taken by Rašín almost a hundred years after his death?
There’s no need to follow everything. But what I liked about him was his toughness, the clear stance he took. He never backed down even after much criticism. He knew what he wanted to achieve and how to make the republic a competitive economy and, as a result, have a strong koruna. We can take some inspiration from that.
And do people understand it? Does the CNB explain its actions clearly enough?
There’s always room for improvement. We’ve now opened a new Visitor Centre where people can come and think about what we’re doing. We need to communicate better to break inflation expectations. They significantly reflect current inflation; they are very backward-looking. When we opened the centre, one of the children wrote us a message on a post-it. It was clear and concise: “I like it here, and especially the strong-room!” Then the child took the piece of paper and stuck it on our special notice board. It was fantastic; this Saturday alone, two and a half thousand people visited the centre. We look forward to seeing people, schools and families visit on a regular basis. I am proud of my colleagues that they have built this amazing place.