The Science, Technology, America, and the Global Economy Program at the Woodrow Wilson Center hosted a National Economists Club meeting with Zdenek Tuma, Governor of the Czech National Bank, on October 9, 2008. In his presentation, Governor Tuma discussed the advantages that the Czech economy has experienced by virtue of the Bank's pursuit of an inflation targeting strategy. In order to highlight the success of this particular regime, the Governor presented data from several Eastern European countries, which either floated their exchange rates or fixed them to the Euro, arguing that inflation targeting under a floating exchange rate could provide better and more stable monetary policy for these emerging economies.

To begin his discussion, Tuma reviewed two key strategies that governments can take with regard to monetary policy – using inflation as a nominal price anchor or employing a pegged exchange rate to create price stability. These two types of policy correspond to choices for exchange rate regimes – floating or fixed, respectively.

Tuma then examined the challenges and potential benefits of each policy. He presented data comparing inflation rates for the Czech Republic, Estonia, and Latvia since 2004, which showed that the Czech Republic had maintained consistently lower price increases under a float than either of the other two countries had achieved through a pegged exchange rate.

He also pointed out that the Czech Republic had seen relatively low output volatility during this period. While some economists attribute this success to the so-called "Great Moderation," others have explained that inflation targeting is a very effective policy for producing price stability without undue output volatility.

Next, the Governor discussed the Czech National Bank's transition to inflation targeting in 1999. He highlighted the point that current global instability will be a major test for the continued success of the Czech economy, in general, and specifically the Bank's monetary policy, but also noted that several countries with inflation targeting had been "doing better" than those nations with currencies fixed to the Euro.

Finally, Mr. Tuma discussed the various factors that might make different Eastern European countries choose to either float or fix their exchange rates. He explained that inflation targeting had served the Czech Republic well so far, but that other countries might find a pegged currency more amenable. In closing, he stated that monetary strategy is subordinate to good governmental policies and noted that the success of either a floating or fixed exchange rate relies first on capable and informed institutions.

Drafted By Andrew Polk, STAGE Program
Kent Hughes, Director, STAGE Program