Download The 1997 monetary crisis – its causes, solution and consequences

The 1997 monetary crisis – its causes, solution and consequences
I.
The 1997 monetary crisis – why did it happen?
1) Overheating the Czech economy since 1995
2) Exchange rate regime
3) Influx of foreign capital and “hot money”
4) Monetary policy of CNB
II.
The development of the crisis
1) Symptoms of the on-coming shake-off
2) Two crisis weeks of May 1997 in facts
III.
Some important consequences
1) Results of the crisis solution
2) The governmental breakdown
3) Changes in monetary policy
IV.
Two antagonistic explanations of the crisis
1) The explanation of Czech National Bank (vice-governor Oldřich
Dědek)
2) The explanation of Václav Klaus – the premier at that time
Overheating the Czech economy:
 the economic growth culminated in 1995
 excessive domestic demand due to the fast real wages growth
 home capacities insufficient  imports as a natural valve of
excessive demand
 huge current account deficits  pressure on CZK depreciation
Exchange rate regime:
 fixed exchange rate with central parity at 28 CZK/1 USD and
fluctuation zone 5 % (15 % since February 1996 )
 undervalued exchange rate as another “transformation pillow”
 fixed exchange rate was an efficient instrument to fight the
inflation
 since 1995 problems tied to this ER regime (current account
deficits,
liberalized
capital
flow

pressure
on
CZK
depreciation)
 question of introducing the “crawling peg”
Influx of foreign capital:
 problem of synchronic existence of fixed exchange rate regime
and liberalized capital flow
 minimal exchange rate risk and higher real interest rates in
comparison to other countries
 increasing ratio of short-term capital influx (“hot money”) 
pressure on future currency depreciation
 virtually no problem with current account deficits – financial
account assured the total surplus of BP and the increase of
foreign currency reserves
 dangerous structure of BP – time bomb of monetary crisis
Monetary policy of CNB:
 restrictive in early 1990s, since 1993 expansionistic
 in 1995 a large liberalization of capital flow
 in Feb. 1996 widening the fluctuation zone of CZK to 15 %
 bond sales to eliminate the excessive growth of monetary base
induced by the massive foreign capital influx
 crowding-out effect of bond sales  another growth of interest
rates  another influx of “hot money”
 the need of a restriction  July 1996 increase of mandatory
minimal reserves by 2 points and increase of basic interest rates
Development of the aggregate M1 (billions of CZK)
600
500
400
300
200
100
0
I.94
I.95
I.96
I.97
V.97
I.98
Source: Centre for Economics and Politics 5/2000
I.99
Monetary crisis symptoms:
 wrong prediction of macroeconomic aggregates  SB in deficit
 April 1997 – first “package” (cut of SB expenditures)
 inner conflicts in the minority government  political
destabilization
 beginning monetary crisis in Southeast Asia  global
investment nervosity
 inaction of Czech National Bank
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 %
20.5.97 Partial appreciation of CZK, negotiations of governmental reconstruction
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
23.5.97 Another intervention of CNB, basic IR is raised to 75 %
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
Exchange rate CZK/DEM during the crisis days
19,60
19,10
18,60
18,10
17,60
17,10
16,60
16,10
97
97
97
97
97
97
97
97
97
.19
.19
.19
.19
.19
.19
.19
.19
.19
5
5
5
5
5
5
5
5
5
.
.
.
.
.
.
.
.
.
13
15
17
19
21
23
25
27
29
Source: Centre for Economics and Politics, 5/2000
Situation before and after the monetary shake-off
30.4.1997
30.5.1997
10,79 %
151,88 %
14 %
50 %
10,5 %
13 %
11,518 billion USD
10,025 billion USD
Exchange rate CZK/DEM
17,903
19,180
Exchange rate CZK/USD
31,005
32,691
Fixed ER with 15%
Controlled floating without
fluctuation zone
official fluctuation zone
Overnight interest rate
Collateral loan rate
Discount rate
Foreign currency reserves of
CNB
Exchange rate regime
Other consequences:
 personal changes in the minority government
 inner governmental conflicts escalated in November 1997 
government abdicated
 premature parliamentary elections in 1998
 changes in monetary policy – difficulties in targeting the monetary
base
 since 1998 CNB targets the “core inflation”
Oldřich Dědek explanation
Bad
macro-
and
Václav Klaus explanation
microeconomic Good
situation
situation
of
the
national
economy till 1996
No willingness to calm down the Parliamentary elections in 1996 
economy
minority government
Expansionistic fiscal policy instead No central bank cooperation
of the restriction
No governmental cooperation
Strong monetary restriction in June
1996
Constrained monetary restriction
Insisting on the fixed ER regime