On 31 January 2014 the Czech National Bank (Česká
národní banka – CNB) published online a research paper regarding monetary
policy transmission in the Czech Republic.
The paper, submitted in October 2013 and published on 31 January in the
central bank’s series of Research and Policy Notes, was written by six
researchers at the Czech National Bank and one Czech consultant in Washington,
DC.
The abstract of the paper reads as follows:
What We Know About Monetary Policy
Transmission in the Czech Republic: Collection of Empirical Results
This paper concentrates
on describing the available empirical findings on monetary policy transmission
in the Czech Republic. Besides the overall impact of monetary policy on
inflation and output, it is useful to study its individual channels, in
particular the interest rate channel, the exchange rate channel, and the wealth
channel. The results confirm that the transmission of monetary impulses to the
real economy works in an intuitive direction and to an intuitive extent. Our
analyses show, however, that the global financial and economic crisis might
have somewhat slowed and weakened the transmission. We found an indication of
such a change in the functioning of the interest rate channel, where elevated
risk premiums played a major role.
JEL [Journal of
Economic Literature classification] codes: C11, C32, E44, E52, E58
Keywords: Bayesian,
monetary policy transmission, time-varying parameters, VAR [vector
autoregression] model
Although the paper is not entirely concerned with
interest rates, it nevertheless contains a very lucid explanation of how
central banks’ “interest-rate channel” for monetary policy transmission is
intended to work. The explanation is
reproduced in full below:
2. Setting the Stage: Stylized Description of Monetary
Policy Transmission and Empirical Literature Review
2.1 Stylized
description of transmission from policy interest rates to inflation
The basic scheme of transmission from policy interest
rates to inflation is depicted in Chart 2.1.1. Therefore, we focus on
conventional monetary policy in this description and abstract from various unconventional
measures. The primary transmission channels include the interest rate channel,
the exchange rate channel, the credit channel, and the asset price channel. The
importance of particular channels in a particular economy depends on the
openness of the economy, its financial system development, as well as the role
of the banking sector. Other channels of monetary policy transmission include
the expectations channel and the risk-taking channel.
Through the interest rate channel, monetary
policy influences the real economy by changing key interest rates. As
consumption, saving, and investment decisions are typically based on long-term interest
rates, the first necessary condition for effective monetary policy is a
functioning channel of transmission of monetary policy interest rates to
financial market interest rates.2 The changes in financial market interest rates
influence the costs of interbank borrowing, to which banks subsequently react
by adjusting their deposit interest rates (the alternative bank financing
cost). At the same time, the changes in the cost of bank financing influence
the interest rates on loans provided by banks. In the end, client interest
rates on deposits and loans enter the optimization process of economic agents
in terms of intertemporal substitution or valuation of economic projects.
2 This transmission typically works due to the
no-arbitrage relationship between these two types of interest rates. The elevation
of spreads between monetary policy interest rates and financial market interest
rates during the global financial crisis was in contradiction with this
assumption. This paper abstracts from this issue.
The existence of imperfect information and
substitution between financial assets in bank-based economic systems cause the
transmission of interest rate changes to be inhomogeneous across economic agents
(credit channel).3 The heterogeneity of effects on firms is caused
mainly by the availability and value of collateral, and is reflected in the
availability and conditions of loans (financial accelerator, balance-sheet
channel); firms with worse financial positions are affected by a monetary
policy tightening more than firms with good financial positions. In the case of
banks, the credit channel is linked to agency costs and the
strength of bank balance sheets, which determine the external premium of bank
financing and banks’ access to external sources and influence the changes in
the credit supply after monetary policy changes.
3 For the purposes of this publication, the existence of
the credit channel in the Czech Republic was analyzed using the methodology of
Iacoviello and Minetti (2008) using monthly data for 2004–2009. However, the
results do not appear to be robust enough, therefore credit channel analysis is
not included in the following text.
The effect of the exchange rate on inflation is
especially substantial for very open economies. An exchange rate shock has a
direct effect on consumer inflation through prices of imported consumer goods.
Indirect effects include the price effects of substitution between domestic and
foreign goods, changes in the domestic prices of raw materials and intermediate
goods, and changes in the monetary policy stance.
Figure 2.1.1: Primary Transmission Channels Between
Change in Key Monetary Policy Interest Rates and Inflation
The asset price channel can cause asset price
adjustments induced by interest rate changes to influence the value of
households’ and firms’ balance sheets, which is reflected in their confidence
in the economy. The effectiveness of this channel for households is conditional
on their perceptions about whether growth in real estate prices and financial
asset prices increases wealth and is a source of consumption spending. In the
case of firms, growth in a firm’s stock market value makes investment capital
relatively cheaper (Tobin’s Q).
Because the authors are economists, they naturally
overlook in the figure above (but do not overlook entirely in the text of the
paper) what is perhaps the most crucial link in the entire chain. Between “INTEREST RATE CUT” and “Decrease in
market interest rate” there should be inserted a step entitled “Flooding of
market with low-interest liquidity via open-market operations”.
Indeed if the central bank did not enter into
competition with savers by temporarily (in the case of a repo) creating money
out of nowhere and lending it at below-market interest rates to financial
institutions, then financial institutions would be forced to obtain these
necessary funds by turning to savers and offering them attractive interest
rates on deposits. Open market
operations are, by their very nature, anti-market operations, intended
to de-level the supply/demand playing field and give one side an
advantage. If, conversely, the central
bank were to give preference to depositors instead of banks, such as by
bypassing banks and soliciting deposits directly from savers and paying them
20% a.p.r. interest, then it would be the banks that would suffer and
the savers who would win. (This latter
strategy, to all appearances, has yet to show up in the “monetary policy
toolbox” of a central bank anywhere in the world.)
The figure shown above indicates that the central
bank’s cutting of its “policy interest rate” in the end leads – via the
open-market operations that are omitted in the figure – to inflation. That is, overall there will be no net
enrichment of the nation’s economy. But
there will be an enrichment of some “economic agents” at the expense of others,
and the figure makes it evident who these will be:
- In the exchange rate channel, the early gainers will be those who
are holding significant amounts of foreign currencies, at the expense of
those who are holding significant amounts of the currency that the central
bank intervenes in (in this case the Czech koruna, or CZK).
- In the interest rate and credit channels, the early gainers will
be those who have large debts, at the expense of those who have little or
no debts (savers or those who consider it a virtue to live within their
means). In addition, lower
non-performing loan (NPL) ratios for banks will cut the losses and improve
the capital adequacy of banks holding large quantities of NPLs, a gift to
those who are shareholders of the more riskily run banks at the expense of
those who do not own stock in risky banks.
- In the asset price channel, the early gainers will be those who
own assets (real estate, stocks, motor yachts, etc.), at the expense of
those who do not own assets, such as the poor or those who have placed
their accumulated wealth in a bank in the form of savings.
In short, the authors make it clear that central-bank suppression
of interest rates, carried out through temporary open-market operations
(repos), leads in the end to inflation for everyone, but in the meantime is an
effective means to transfer wealth from the poor and savers (especially savers
who deposited their money in the domestic currency) to those who have gambled
with high leverage (debt), who hold large amounts of cash in foreign
currencies, who own stock in banks, or who own assets.
Sources:
Abstract and
link to paper: What
We Know About Monetary Policy Transmission in the Czech Republic: Collection of
Empirical Results (2014-01-31)
Paper: What
We Know About Monetary Policy Transmission in the Czech Republic: Collection of
Empirical Results (2014-01-31 09:48:22)
Database of
CNB open-market operations, day by day: History
of CNB open market operations - OMO
