The Causes, Solution and Consequences of the 1997 Monetary Crisis nSituation of the Czech economy before the crisis nThe 1997 monetary crisis – why did it happen? nThe crisis development nConsequences of the crisis nDifferent crisis explanations nPresentation availability: in „Study materials“ at is.muni.cz Czech economy in the middle of the 90´s nsatisfactory stage of the economic reform nmost basic reform steps were made nsolid economic growth nlow unemployment rate ngood future view of macro aggregates Czech economy in the middle of the 90´s Source: Czech Statistical Office, www.czso.cz Czech economy in the middle of the 90´s Unemployment rate in the Czech Republic Source: Czech Statistical Office, www.czso.cz The 1997 crisis – why did it happen? nseveral causes (factors) nall of them „worked“ together ndirect relationship between the external imbalance and the Czech koruna exchange rate n4 main causes: excessive domestic demand, exchange rate regime, short-term foreign capital influx, monetary policy 1. Overheating of the Czech economy → excessive domestic demand n1994-1996 one of the fastest economic growths in Europe nexcessive domestic demand (theory of „transformation wage pillow“) ninsufficient domestic supply nimports as a natural valve of this imbalance nhuge current account deficits npressure on the CZK depreciation Relationship between GDP growth (g) trade balance (NX) g NX 1992 1993 1996 NX BP development Current Account Financial Account Change of Reserves Source: Czech Ministry of Finance Deepening CA Deficit 2. Exchange rate regime nfixed exchange rate regime since the beginning of the transition process ncentral parity at 28 CZK/1 USD with +- 0,5% fluctuation zone nundervalued CZK as another „transformation pillow“ ngood anti-inflation instrument nbut: real exchange rate problem nquestion of „crawling peg“ implementation Real CZK exchange rate nRD/F = ED/F . PF/PD where: nRD/F…real exchange rate domestic/foreign currency nED/F…nominal exchange rate domestic/foreign currency nPF…foreign price level, PD…domestic price level nif R > 1, domestic goods relatively cheaper → to acquire 1 foreign cage of goods you have to offer more than 1 domestic cage of goods nif R < 1, foreign goods relatively cheaper → to acquire 1 foreign cage of goods you have to offer less than 1 domestic cage of goods Real exchange rate CZK/DEM, 1991=100 Source: Vencovský, Komárek (1998) For example: if you got 1 German commodity cage for 500,- CZK in 1991, you could get the same German commodity cage for cca 250,- CZK in 1998 → that's how the real appreciation of CZK worked Real CZK exchange rate Exchange rate trends – relation Czech Republic – Germany (1991=100) Source: Vencovský, Komárek (1998) Inflation differential Relationship between real exchange rate (R) and trade balance (NX) NX R 1992 1993 1996 NX revaluation devaluation 3. Influx of short-term foreign capital nproblem of co-existence of fixed exchange rate regime and liberalized capital flows nminimal exchange rate risk for foreign capital npositive interest-rate differential (Czech real interest rates higher than in other transition countries) nincreasing ratio of short-term capital on the financial account nvirtually no problem with current account deficits – CA def. covered by FA surpluses nbut: dangerous structure of BP BP development Current Account Financial Account Change of Reserves Capital flows liberalization 4. Monetary policy of Czech National Bank nrestrictive monetary policy in the early 90´s – main goal – decrease inflation nsince 1993 – slightly expansionistic – main goal – economic growth n1995 – full liberalization of capital flows – since that – increase of short-term capital influx nFebruary 1996 – widening of fluctuation zone of CZK to +-7,5% - the goal to raise the exchange rate risk nbond-sales to eliminate the excessive growth of monetary base ncrowding-out effect of bond-sales – another growth of interest rates, and another influx of short-term capital nin 1996 – the need of restriction – middle 1996 – CNB increased the minimal required reserves rate, and basic interest rates n n1996 monetary restriction as the brake of economic growth nslower economic growth – impulse for short-term foreign capital to „cast away“ Monetary policy of Czech National Bank Source: Centre for Economics and Politics (2000) Monetary Restriction Development of the crisis nwrong prediction of macroeconomic aggregates for 1997 nApril 1997 – state budget deficit (the new phenomenon) nfirst „parcel of economic measures“ – cut of SB expenditures by cca 25 billion CZK (cca 5% of total expenditures) ninner conflicts in the minority government – political destabilization nbeginning monetary crisis in Southeast Asia Development of the crisis nfirst attack on the CZK: 15th May 1997 nforeign short-term capital started to reflux nCzech National Bank tried to keep the CZK exchange rate nunequal „battle“ between the speculates and Czech National Bank BP development Current Account Financial Account Change of Reserves Start of the Monetary Crisis Most important facts of the 2 crisis weeks Date Important facts 15.5.97 CZK depreciates by 5 %, first intervention of the central bank 16.5.97 Pressure on the CZK continues, CNB raises the collateral loan interest rate to 50 % 19.5.97 Another intervention of CNB, overnight IR rose to 38 % 21.5.97 CZK under another attack, inter-bank IR rose to 500 % at one moment 22.5.97 Sharp drop of CZK, CNB disallows foreigners obtaining short-term loans in CZK, firms and people convert deposits to foreign currencies, CNB loses 500 million USD 24.5.97 Three ministers declare the aim to leave the government 26.5.97 ER regime changed to “controlled floating”, former fluctuation zone cancelled 27.5.97 CZK ER overshoots to 19,40/1 DEM 28.5.97 CZK stabilized, the government introduces a program “the recovery package” of measures, personal changes in the government 29.5.97 CZK returns to the border of former fluctuation zone, situation calms down CZK exchange rate during the crisis Source: Centre for Economics and Politics (2000) Main variables before and after the crisis 30.4.1997 30.5.1997 Overnight interest rate 10,79 % 151,88 % Collateral rate 14 % 50 % Discount rate 10,5 % 13 % Foreign currency reserves of CNB 11,518 billion USD 10,025 billion USD Exchange rate CZK/DEM 17,903 19,180 Exchange rate CZK/USD 31,005 32,691 Exchange rate regime Fixed ER with 15% fluctuation zone Controlled floating without official fluctuation zone Consequences of the crisis nshort-term consequences: npersonal changes in the minority government ngovernmental breakdown in autumn 1997 nsharp devaluation of CZK, change of ER regime nmid-term consequences: npremature parliamentary elections in 1998 nchanges in monetary policy neconomic recession in 1997 and 1998 nconstant unemployment growth since the end of 1997 The two different crisis explanations nOldřich Dědek – vice governor of CNB nVáclav Klaus – premier in 1997, current president of the Czech Rep. Oldřich Dědek explanation Václav Klaus explanation Bad macro- and microeconomic situation Good situation of the national economy till 1996 No willingness to calm down the economy Parliamentary elections in 1996 Þ minority government Expansionistic fiscal policy instead of the restriction No central bank cooperation No governmental cooperation Strong monetary restriction in June 1996 Constrained monetary restriction Insisting on the fixed ER regime