Interview of Aleš Michl, CNB Governor
Jakub Svoboda (Právo, novinky.cz 7. 8. 2022)
Interest rates are high enough and a further forceful hike wouldn’t make sense now, because they are having only a small effect on inflation due to its nature, the new Governor of the Czech National Bank (CNB) Aleš Michl tells Právo in his first major interview.
On Thursday, Michl chaired his first monetary meeting of the CNB Bank Board since taking the helm at the CNB. For the first time in more than a year, the policy rate was not increased and stayed at 7%. How come?
We’re being hit by waves of bad news. It’s causing fear. The central bank now needs to be a firm anchor stabilising conditions in the economy. Interest rates are now at a level that is dampening domestic demand pressures. They are slowing growth in bank loans to households and firms and hence also in the quantity of money in the economy. That’s why they need to be kept stable.
But the CNB has admitted that inflation is heading towards 20%. Inflation expectations haven’t stopped rising. The koruna is tending to weaken. And despite the weakening domestic demand, the economy isn’t slowing down as expected either…
Yes, annual inflation is set to reach around 20% by the year-end. But it’s mainly cost-driven. Interest rates have little effect on the type of inflation we are seeing this year. If energy prices stop rising next year, the good news is that inflation should decline to close to 2% in a year and a half according to the CNB’s forecast.
And if energy prices don’t stop rising?
If energy prices keep going up, they’ll only be stopped by a big recession. But we don’t expect that now.
You’ve said repeatedly that inflation should fall to 2% in a year and a half. What do you base your optimism on?
Growth in the quantity of money in the economy is slowing. It’s a sign that inflation is being dampened. The unpleasant but inevitable decline in people’s real purchasing power will reduce consumer demand, and hence also inflation, next year.
Didn’t the Board’s decision on Thursday reflect the fact that the new members, who, like you now, took up their posts promising to change policy and regard rates as sufficiently high – I mean Eva Zamrazilová and Jan Frait, simply wanted to keep that promise at their first monetary policy meeting.
I don’t know about any promise. The new Bank Board members are professionals with many years’ experience. Eva Zamrazilová has served on the Bank Board before and also has fiscal policy experience.
Karina Kubelková has extensive private sector experience as well as huge macroeconomic knowledge.
Jan Frait was previously a board member and has worked at the CNB for more than 20 years. He has extensive experience.
At the board meeting on Thursday, they all debated and decided in accordance with their convictions on the basis of the current data and the economic outlook.
But aren’t you afraid that the surging inflation will ultimately force you to capitulate this year and raise rates further?
A further forceful rise in rates makes sense only in the event of impending high demand inflation. This year, however, inflation is accelerating mainly because of costs. It’s imported – we are unable to lower the price of electricity, gas and petrol by raising rates. With the current type of inflation, we need to do something else…
What, specifically?
From my point of view, the three key conditions for lowering inflation, in order of importance, are as follows. First, the pace at which the country’s debt is rising has to be reduced. Second, a wage-inflation spiral must be prevented. Wage growth must therefore reflect labour productivity growth, not price growth in the economy. Third, interest rates need to be kept higher than they have been over, say, the past 10 years.
Rates lie within the competence of the CNB. You’re going to be deciding on them another three times this year. What level will they have reached by the end of the year?
We now have stable rates in the forecast. But we will reassess the data at each subsequent monetary meeting. We will reconsider everything and decide again.
Has the atmosphere in the altered Board changed in any way compared with previous monetary meetings?
I’m looking to the future. I won’t assess the past Bank Board.
You are said to have the reputation of an eccentric and a loner who popularises economics, but perhaps because of that, you also often use straight talking instead of the cautious language of central bankers. Will that change now you are head of the CNB?
The straight talking is here to stay. As governor I will add consensus-seeking and compromise.
The majority of the bankers around your predecessor Jiří Rusnok were hawks. The former governor said that when inflation hits double figures, where and how it originated is not all that important any more. Even if the growth in energy prices can’t be stopped by hiking rates, there’s simply no way to dampen inflation expectations and slow the inflationary spiral other than to raise rates.
The central bank now has a new strategy. Mr Rusnok, who, by the way, I thank for his assistance, is the past.
Why is it important for rates to stop going up, or to go up only moderately? 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.
Those are the three key conditions I mentioned.
Interest rate decisions usually have an effect with a lag of a year to a year and a half. Wouldn’t inflation now be somewhere around 30% without the rate hikes you voted against, which started last June?
I don’t know what such estimates are based on. There are countries in Europe where interest rates are far lower and inflation is simultaneously lower. There is no simple correlation between the level of rates and inflation at the moment.
Jiří Rusnok has claimed that if the CNB hadn’t raised interest rates, inflation would have been running at least at 20–25% in May and the exchange rate would have been 30 korunas to the euro…
Again, that’s the past. I wouldn’t go back to it. What ifs are irrelevant now. I want to deal with the future.
So what other tools do you intend to combat inflation with, if not rates?
But we are combating the demand part of inflation with rates. Rates are now at their highest since 1999. That we have now decided to keep them stable doesn’t mean that they are no longer having an effect.
How can the government contribute to taming inflation?
It can reduce the pace of growth in the country’s debt and not enter into debate with the trade unions about wage growth that is out of line with productivity growth. But I admit that’s easier for me to say, as I don’t need to win elections.
Foods and some other goods are going up in price faster in the Czech Republic than elsewhere in Europe. It turns out that some producers and retailers are abusing the situation of rising prices and significantly increasing their profit margins. Can anything be done to stop this?
The recipe is healthy competition, so that supply isn’t limited by bureaucracy or green ideology.
Don’t you regret what you said on your appointment as governor in May that you would propose to keep rates stable in August? According to analysts, it led to the koruna weakening and the CNB having to intervene, i.e. sell off its international reserves, to “put out the fire”.
On the contrary, I would say the same again. I stuck to the message of my speech, and that’s the way it will always be. If I’d said back then that I wanted to continue raising rates quickly, the koruna would have strengthened, because these short-term swings are caused by speculators looking to turn a quick profit. However, not only would I have not been telling the truth, but the depreciation pressure on the koruna would have been all the greater now. As regards whether or not the then Bank Board had to intervene to put out the fire, as you put it, I gave my opinion on the record at a closed board meeting, and that record will be published in six years’ time. Those are the rules and that’s fine. It’s of no importance now. Let’s look to the future.
How much of its international reserves has the CNB sold since your appointment? And do you intend to continue the interventions? How large might they be?
We publish the official data with a delay of 40 days. In May we sold EUR 3.5 billion and obtained, or withdrew from the market, CZK 86 billion. It was an anti-inflationary operation. We reduced the quantity of money in the economy. We will publish the data on the June interventions on 9 August.
Our reserves are still worth around 60% of GDP. We have one of the highest levels in the world. I’ll say one thing on the future of these operations: the Bank Board will continue to prevent excessive fluctuations in the exchange rate of the koruna.
Given the events in the euro area and the monetary policies of large central banks, which way can we now expect the koruna to go?
I never predict the exchange rate of the koruna, because just like everyone else I don’t know how.
Yet you admit that you are intervening to strengthen the koruna, and at the same time the CNB forecast states that the Czech currency will weaken to CZK 26 to the euro by the middle of next year. What factors will affect the exchange rate of the koruna?
That CZK 26 is an output from our Monetary Department’s model. It’s more of a technical assumption than a forecast. 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 when 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. 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.
Tradition and the law say that monetary policy should be kept strictly separate from fiscal policy. But you are publicly urging for austerity policies, and I think you even said you wouldn’t be against holding consultations with Finance Minister Zbyněk Stanjura (ODS). Come to that, he also attended your interest rate meeting on Thursday…
I am able talk in an apolitical and professional way both with (former finance minister and head of the opposition ANO movement) Alena Schillerová and with Finance Minister Stanjura. But at monetary meetings I will always vote according to what I believe is best. And I expect the same of the other Bank Board members – professional relations with the Finance Minister in particular. By law we are also the bank of the state.
According to economists, the former government of Andrej Babiš (ANO), whom you worked for as an adviser, also contributed to the inflation spiral with its massive spending. Do you agree?
I don’t have the remit to assess political decisions.
ANO together with the ODS pushed through the abolition of the super-gross wage and an income tax cut, which actually involves the poor showing solidarity with the rich. Jiří Rusnok called it Robin Hood in reverse. On top of that, it widens the budget deficit by some CZK 90 billion every year. That’s also contributing to the debt you mention.
I must repeat that I don’t have the remit to talk about the level of taxation in the country. The communication of the central bank is to change in that regard. My sole message to politicians is: reduce government deficits and don’t give in to the unions, because it’s important for reducing inflation.
You are fond of referring to Alois Rašín, the interwar Czechoslovak minister of finance. What is it that inspires you so much about this politician, who wasn’t too popular with the public?
His straight talking. By the way, isn’t that what you chided me for just now?
You are calling for austerity, just like bank analysts, who, given their incomes, also probably aren’t being hit too hard personally by the rising prices. Shouldn’t central bankers and politicians lead by example and freeze their pay again next year?
The Bank Board will have its pay frozen this year. We will decide what comes next at the board meeting at the end of the year.
Constitutional officials have had their pay frozen for this year. But a freeze is no longer expected for next year. Would that be asking too much?
That’s a political decision.
What about the much-debated inflation clause for CNB employees?
Our employees have a clause in their collective agreement that their pay should increase by inflation plus two and a half percentage points this year and next year. We – the bank’s management, not the unions or our employees – made a big mistake in approving that in the past. I am trying personally to address this and I’m renegotiating to prevent such a large increase, and I apologise that we did not lead by example at the central bank.
The government is negotiating with the unions on public sector pay growth. People have to pay their bills and buy increasingly expensive food. Is it possible for you as an economist to find a compromise here, given the risk of driving inflation up further?
The compromise should be that wage growth should be in line with labour productivity growth, not inflation.
The government has conceded the possibility of a slight increase in pay. In addition, it is introducing, for example, a CZK 5,000 contribution for children and increases in benefits to help people out…
Again, that’s a political decision. On government spending, I’ll just say that no crisis should lead us back to socialism, a situation where everyone demands support, uses up resources and wastes them, and does not take into account productivity and output quality. Otherwise, we will not be able to stabilise debt and slow inflation. We simply can’t be led solely by the reflex to suck on government money, as described by János Kornai (the Hungarian reform economist – Ed.). There is no easier way.
But mortgage rates are going up, energy is swallowing up more and more of people’s money, and many are failing to make ends meet. In your view, would a debt moratorium like the one we had during Covid help households? Would you support that?
It wouldn’t and I wouldn’t.
Why?
Because I’m against having an entitlement economy where in every crisis the government keeps helping out and people keep sucking on the teat. The laws and regulations are set up so that banks have to be fair with their customers in such a situation. Deferred payments can also be agreed on an individual basis.
The government is planning a windfall tax on energy firms and maybe banks as well, like in Spain. Is that the right way to go? And would it have an adverse effect on banks?
It’s purely a political decision. The central bank should not interfere in it in public. I gave Mr Stanjura my opinion face to face on Thursday and that’s an end to it.
Do you think the government can get by without increasing income tax or VAT?
Again, I can’t comment, as it’s a political decision.
But you said that the central bank and the government need to talk to each other now. About what, then?
We have a joint goal – tackling problem number one: the high inflation.
What are the main risks to the Czech economy for the rest of this year and for next year?
High inflation and potential problems caused by energy shortages.
Do you think the Czech economy will fall into recession?
We expect a modest recession in our new forecast.
Another of the changes you would like to make is to change the structure of the international reserves, which according to the CNB website stood at EUR 151 billion (CZK 3.7 trillion) at the end of June and consist predominantly of euros. Why?
My vision is that the CNB should be profitable in the long term. We’re currently recording a big loss. I’d like to set up a strategy so that the expected return on assets, i.e. international reserves, in the long term exceeds the cost of the central bank’s liabilities, which are mainly the deposits of banks that we have to remunerate.
To give you an idea, this year we will pay banks around CZK 160 billion in interest on their deposits. 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. In six years, I want to hand over to my successor a bank that has a chance of being profitable in the long term.
Does that mean you want to increase the proportion of shares? Gold as well? By how much?
Yes, we need to increase the expected return on our assets – international reserves – and simultaneously diversify and monitor risk. I will propose at our Asset and Liability Committee a gradual increase in the proportion of shares from the current 16% of reserves to 20% or more. The central banks of Switzerland and Israel, and large sovereign wealth 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.
