Inflation targeting in the Czech Republic

This paper presents the Czech approach to inflation targeting (IT) that was co-authored by the authors of the paper. The IT strategy was introduced by the Czech National Bank in 1997. The paper gives an overview of history of monetary policy in the Czech Republic and reasons for a change in strategy. Similarly to the countries that adopted the inflation targeting, the Czech republic lost its nominal anchor when letting domestic currency to float. Monetary targeting was not an option due to weaker links between both the price level and money supply a well as money supply and interest rates. In the next section, the paper describes the problems of implementation of inflation targeting in transitional country and solutions adopted by the Czech National Bank. Specifically, the issue of regulated prices is discussed and definition of the net inflation index. Also, the strategy of desinflation and its representation by a set of two targets for different time horizons is analyzed. The overview of the first months of decision-making process under the new strategy shows that it promotes both internal as well as external transparency of monetary policy. In the last section, several lessons are derived for inflation targeters in transitional countries from the Czech experience. For example, the importance on society preferences towards price and currency stability is emphasized. Also, the conflict between a necessity of anchoring expectations and longer lags of monetary policy is explained. It is concluded that despite the problems, the inflation targeting provides significant gains for transitional economy.