The Causes, Solution and Consequences of the 1997 Monetary Crisis n Situation of the Czech economy before the crisis n The 1997 monetary crisis – why did it happen? n The crisis development n Consequences of the crisis n Different crisis explanations n Presentation availability: http://pmusil.czechian.net/transformation.htm Czech economy in the middle of the 90´s n satisfactory stage of the economic reform n most basic reform steps were made n solid economic growth n low unemployment rate n good future view of macro aggregates Czech economy in the middle of the 90´s Czech economy in the middle of the 90´s The 1997 crisis – why did it happen? n several causes (factors) n all of them „worked“ together n direct relationship between the external imbalance and the Czech koruna exchange rate n 4 main causes: excessive domestic demand, exchange rate regime, short-term foreign capital influx, monetary policy 1. Overheating of the Czech economy → excessive domestic demand n 1994-1996 one of the fastest economic growths in Europe n excessive domestic demand (theory of „transformation wage pillow“) n insufficient domestic supply n imports as a natural valve of this imbalance n huge current account deficits n pressure on the CZK depreciation BP development Exchange rate regime n fixed exchange rate regime since the beginning of the transition process n central parity at 28 CZK/1 USD with +- 0,5% fluctuation zone n undervalued CZK as another „transformation pillow“ n good anti-inflation instrument n but: real exchange rate problem n question of „crawling peg“ implementation Real CZK exchange rate n R[D/F] = E[D/F] . P[F]/P[D ] where: n R[D/F]…real exchange rate domestic/foreign currency n E[D/F]…nominal exchange rate domestic/foreign currency n P[F]…foreign price level, P[D]…domestic price level n if R > 1, domestic goods relatively cheaper → to acquire 1 foreign cage of goods you have to offer more than 1 domestic cage of goods n if 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 CZK exchange rate Influx of short-term foreign capital n problem of co-existence of fixed exchange rate regime and liberalized capital flows n minimal exchange rate risk for foreign capital n positive interest-rate differential (Czech real interest rates higher than in other transition countries) n increasing ratio of short-term capital on the financial account n virtually no problem with current account deficits – CA def. covered by FA surpluses n but: dangerous structure of BP Monetary policy of Czech National Bank n restrictive monetary policy in the early 90´s – main goal – decrease inflation n since 1993 – slightly expansionistic – main goal – economic growth n 1995 – full liberalization of capital flows – since that – increase of short-term capital influx n February 1996 – widening of fluctuation zone of CZK to +-7,5% - the goal to raise the exchange rate risk n bond-sales to eliminate the excessive growth of monetary base n crowding-out effect of bond-sales – another growth of interest rates, and another influx of short-term capital n in 1996 – the need of restriction – middle 1996 – CNB increased the minimal required reserves rate, and basic interest rates Monetary policy of Czech National Bank n 1996 monetary restriction as the brake of economic growth n slower economic growth – impulse for short-term foreign capital to „cast away“ Development of the crisis n wrong prediction of macroeconomic aggregates for 1997 n April 1997 – state budget deficit (the new phenomenon) n first „parcel of economic measures“ – cut in SB expenditures by cca 25 billion CZK n inner conflicts in the minority government – political destabilization n beginning monetary crisis in Southeast Asia Development of the crisis n first attack on the CZK: 15th May 1997 n foreign short-term capital started to reflux n Czech National Bank tried to keep the CZK exchange rate n unequal „battle“ between the speculates and Czech National Bank Most important facts of the 2 crisis weeks CZK exchange rate during the crisis Main variables before and after the crisis Consequences of the crisis n short-term consequences: n personal changes in the minority government n governmental breakdown in autumn 1997 n sharp devaluation of CZK, change of ER regime n mid-term consequences: n premature parliamentary elections in 1998 n changes in monetary policy n economic recession in 1997 and 1998 n constant unemployment growth since the end of 1997 The two different crisis explanations n Oldřich Dědek – vice governor of CNB n Václav Klaus – premier in 1997, current president of the Czech Rep.