Non-standard Monetary Policy in a Low Interest Rate Environment
- International Monetary Fund
- Published Date:
- May 2017
Thank you very much for the opportunity to talk about the Hungarian experience. It comes with the usual disclaimer about the views expressed here. Let’s phrase it in the way that I am analyzing and advising policy, but not making it, unlike some of the participants here. A one-line catchy title would be the Hungarian way, but I chose a somewhat longer one, connecting the title of the presentation and the topic of the conference.
I would like to highlight two important factors, among others, behind the Hungarian monetary policy developments. The first one is the conversion of household FX loans into Hungarian forint in late 2014, which removed the major systemic financial risk from the balance sheets and substantially reduced the FX exposure of the households and also of the whole economy. The second one is ECB’s monetary policy. As it appears in our statements, the eurozone’s monetary policy conditions are highly relevant for Hungary. We have not only been facing accommodative external environment in terms of monetary conditions, but they are also expected to be maintained for a considerable period.
Nevertheless, the Central Bank of Hungary has taken a different approach compared to other central banks in recent years, and has eased its monetary conditions while reducing its balance sheet as shown in Figure 1. Looking at Figure 2, we can see the evolution of balance sheets of some central banks, major central banks, and the central banks of the Central European region.
Figure 1.Monetary policy and balance sheet Figure 2.Central banks’ balance sheet relative to GDP
We can see that the lines representing the Central Bank of Hungary and the European Central Bank balance the sheet’s size as a percentage of the GDP intersect around the middle of 2016. The two lines cross each other, and the Hungarian balance sheet has continued to decrease ever since.
Let me briefly talk about some monetary policy measures, either conventional or unconventional in nature, that have enabled us to conduct loose monetary policy with a shrinking balance sheet. They are summarized in Figure 3. These steps are related to the base rate, the interest rate corridor, the main policy instrument, and the limitation of that, our lending incentive program and a decline in the required reserve ratio. I will touch upon each of these, except for the last one.
Figure 3.MNB recent monetary policy measures
Magyar Nemzeti Bank
Figure 4.MNB base rate and expectations
Let me start with the base rate. Starting in the summer of 2012, the main policy rate has been cut by a total of 6.1 percentage points, in order to achieve our inflation target; meanwhile, an inflation tolerance band was introduced to ensure larger flexibility in case of inflationary shocks. More recently, in the third phase, the base rate was cut by 45 basis points to the new historical low level of 0.9 percent.
In the three consecutive steps from March of 2016 to May 2015, the Council also stated as before its intention to maintain the current level of the base rate and loose monetary conditions for an extended period of time as long as it is consistent with the achievement of the central bank’s objectives. We also see that market expectations or implied yield curves indicate a low interest rate path for a prolonged period. So, in this sense, forward guidance has successfully oriented expectations in Hungary.
Figure 5.Money market yields and the interest rate corridor
The interest rate corridor around the base rate used to be symmetric with a plus/minus 100 basis point range. First, it was shifted by 25 basis points in 2015. Then, the overnight deposit rate was cut to a slightly negative level – to −0.05 percent – simultaneously with the base rate cut in March 2016. Afterward, the upper bound of the corridor declined in several steps until it reached the same level as of the base rate. With the asymmetry of the interest rate corridor, the bank aimed at avoiding a possible increase in the short-term interest rate volatility stemming from the declining liquidity of the system, and, at the same time, managed a decrease in the average overnight interest rate level.
Figure 6.Stock of the main sterilization instruments Figure 7.Short-term market yields and the base rate
Besides, after the previous introduction of the three-month deposit facility and limiting the volume of the two-week facility, in January 2016, the Council decided to gradually phase out the two-week deposit facility. Moreover, in July 2016, the Bank announced that first from August 2016 the three-month deposit tender would be announced once a month instead of the former weekly frequency and also from October 2016 the Bank would limit the amount of banks’ bids accepted at the tender.
Following the announcement, in September 2016, a HUF 900 billion upper limit on the three-month deposit stock was announced to be met at the end of the fourth quarter of 2016. This quantitative restriction crowds the liquidity out from the main deposit facility. If you look at this framework, exhibited in Figure 8, the liquidity is “looking for its place” in the interbank market and is accumulated in another central bank deposit, facility with lower interest rates. This can be preferential deposit which is also a limited instrument available for banks, which have made a commitment for their net lending activity to be positive in a certain period, or it can be overnight deposit, which now has a slightly negative interest rate.
Figure 8.Crowding the liquidity out from three-month deposit facility
The liquidity can present itself in excess reserves, but the interest rate here is the overnight deposit rate minus 15 basis points. Or banks may choose to place liquidity in some securities with preferably longer maturities, which can be used later as collateral. Due to the characteristics of the Hungarian financial markets, these securities are typically government papers, such as treasury bills, and bonds. If we go back, this cap on the three-month deposit is now considered as an integral part of the monetary policy toolkit, and it is set quarterly. In December, it was lowered to 750 billion, and last time it marched across the 500 billion bound, as at the end of the second quarter of 2017, to preserve the amount of the liquidity crowded out of the deposit facility previously and thereby maintaining the loose monetary conditions achieved. This last decrease was mainly motivated by the decline in the banking sector liquidity compared to the previous quarter due to some autonomous liquidity factors and not by an additional monetary easing as before.
Overall, we can see that this limit has resulted in a sharp fall in yields in all relevant markets, as the central bank aims to ease monetary conditions through a decline in money market rates. The Bank also introduced fine-tuning instruments to offset potential liquidity shocks, so it is a quite complex process: we need forecasts for the banking sector liquidity to be able to carefully set these caps on the deposit facility.
And, finally, we had a lending incentive program started in 2013, which ended in March this year. Banks received financing from the central bank, and they lent it with a maximum of 2.5 percent margin. Overall, throughout the program, over 36,000 enterprises received funding, amounting to more than 2,400 billion Hungarian forints, which are equivalent to approximately 8 billion euro and a little above 7 percent of GDP.
As a result, the growth rate of corporate credit stock has returned to the 5–10 percent band, which is the preferred annual growth rate by the central bank. This is evidenced by Figure 9. After the Funding for Growth Scheme (FGS) is phased out in March, the transition to lending under market conditions will be assisted by the Bank’s Market-Based Lending Scheme. It is part of the Growth Supporting Programme of the Bank. It mainly provides some positive incentives for the banks to continue lending to SMEs under market conditions as well.
Figure 9.Funding for Growth Scheme and corporate credit growth
To sum up, the Central Bank of Hungary stopped the rate cut cycle last year, but has eased monetary conditions further. Now inflation is expected to reach the target in a sustainable manner in the first half of 2018, while economic growth has picked up and vulnerability of the country has decreased at the same time.