The persistence of moderate inflation in the Czech Republic and the Koruna crisis of May 1997

Josef Brada and Ali Kutan

No 1998-021, Working Papers from Federal Reserve Bank of St. Louis

Abstract: Macroeconomic policy in the Czech Republic has been based on a fixed exchange rate for most of the post-1993 period and a conservative fiscal policy characterized by a government budget that was close to balance combined with a tight monetary policy that sought to maintain high interest rates and to restrict the growth of the money supply. Surprisingly, given the Czech Republic's good starting conditions for carrying out such a \"soft landing\" in its macroeconomic stabilization, the economy was hit by a speculative attack on the koruna in May, 1997, and the economy, which had shown some signs of an increasing tempo of growth, appears to have slid into recession. At the same time, inflation has proven to be, while moderate by regional standards, surprisingly resistant to dropping below 10% per annum, thus leaving the Czech Republic in an undesirable state of \"stagflation\". with output declining, unemployment rising, and inflation accelerating. In this paper we argue that, although the fixed nominal exchange rate policy may have been retained for too long, and that, while the mix of monetary and fiscal policies was inappropriate given the desire for a fixed nominal exchange rate, the key problem for Czech policy both before and after the abandonment of a fixed exchange rate policy was and is the persistence of a rate of inflation that exceeds that of its major trading partners by a large margin. After explaining the relationship between Czech inflation, exchange rate and macroeconomic policies and the crisis of May, 1997, we examine some explanations for the persistence of inflation in the Czech Republic at a level around 10%. We close by examining the policy implications of our findings in the context of the Czech National Bank's new policy of inflation targeting.

Keywords: Money; Czech Republic; Inflation (Finance) (search for similar items in EconPapers)
Date: 1998
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Citations: View citations in EconPapers (6)

Published in Prague Economic Papers, December 1999

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