Michl outlines 'forever hawkish' CNB policy

Aleš Michl, Governor of the Czech National Bank, outlined the CNB's "forever hawkish" monetary policy approach, emphasizing higher-for-longer interest rates and the integration of AI-based forecasting. Speaking at MIT, Michl reflected on the Czech Republic's journey to tame inflation from 18 percent to 2 percent.

From 18 percent to 2 percent

Governor Michl recounted his tenure at the Czech National Bank (CNB), beginning in July 2022 when inflation stood at 17.5 percent, peaking at 18 percent two months later.

This marked the highest inflation rate in the Czech Republic's modern history, excluding post-Velvet Revolution price liberalization.

By February 2024, annual inflation successfully reached the CNB's 2 percent target, making it one of the first European central banks to do so.

Michl attributed the initial surge in inflation to years of ultra-low nominal and negative real interest rates before Covid, combined with government budget deficits and a cost shock.

He stressed that a "forever hawkish" monetary policy, maintaining higher-for-longer interest rates and positive real rates, is now necessary to offset these past conditions and encourage saving.

Koruna strength and communication

The CNB's strategy involved keeping the key interest rate at 7 percent until inflation was firmly on track to target, coupled with guidance for higher-for-longer rates.

Crucially, the bank actively fought inflation by advocating for a strong exchange rate, which would make imports cheaper.

This "Policy for a Strong Koruna" was presented in November 2022, going against mainstream economic opinion and DSGE model projections.

Despite initial skepticism, the koruna appreciated to its strongest historical level by spring 2023, driven by market forces.

This, combined with the 7 percent interest rate, created the tightest monetary conditions in 20 years.

Michl also detailed extensive public communication efforts, including speeches, interviews across various media, and social networks, to explain the CNB's plan and gain public trust.

The bank also implemented internal cost-cutting measures and froze Board members' salaries to demonstrate responsibility.

Lessons learned, models challenged

The Czech experience highlights the limitations of traditional DSGE models in a small, open economy facing global shocks.

The reliance on a strong exchange rate and the focus on imported inflation proved effective, challenging conventional wisdom.

However, the speech also critically acknowledges past monetary errors, particularly the long period of negative real rates and the exchange rate depreciation policy that fueled excess liquidity.

This suggests a need for central banks to adopt more agile, data-driven approaches, incorporating AI and high-frequency indicators, to navigate complex inflationary environments.