Czech Republic: Selected Issues

This Selected Issues paper applies the IMF’s Integrated Policy Framework (IPF) to the Czech Republic with the aim of contributing to the use of scenario analysis at the Czech National Bank (CNB). The paper identifies some shallowness of foreign exchange markets as the main relevant friction under the IPF. Moreover, while inflation expectations are generally well anchored, they can nevertheless deviate from the inflation target for extended periods. Using an extended version of the Quantitative IPF model, the paper broadens the scope of analysis beyond traditional external shock scenarios, to also include domestic fiscal policy shocks and central bank balance sheet normalization. The paper finds that in the event of a global risk-off outflow shock, the CNB can improve macro stabilization through a combined use of reserves and interest rate policy. The paper also highlights that refocusing fiscal stimulus towards more productive uses greatly reduces the degree of monetary policy tightening are needed to stabilize inflation at target. The paper recommends that balance sheet normalization is optimally implemented in a preannounced and gradual manner, in which potential currency appreciation in principle can be mitigated through a slightly lower policy rate.