THREAD on Hungarian 🇭🇺 monetary policy in #covid19 crisis management. Central bank's announcements today illustrate the dilemma of emerging markets as policymakers face a starker trade-off between providing cheap liquidity and leaning against FX-depreciation pressures 1/n
Just like elsewhere, governments and firms in emerging markets (EM) need cheap liquidity (in local currency) to finance the fight against the #covid19 crisis. This calls for cuts in interest rates by monetary policy. 2/n
At the same time, EMs also suffer a #suddenstop of capital inflows, as #FlightToSafety drives foreign investors away, putting downward pressure on the exchange rate. Even w/o FX-debt (currency mismatch), a sharp depreciation can hurt, being inflationary in an open economy. 3/n
Monetary policy therefore faces a dilemma: cut interest rates to ease financing conditions for firms & government - or raise them to halt exchange rate depreciation and corresp. inflation pressures. Tradeoff bw supporting the economy and price stability emerge faster in EMs 4/n
Hungary 🇭🇺 entered the crisis with inflation at 4% already slightly above target, and interest rates effectively near zero. Since then HUF sharply depreciated 9% in a month. Currency mismatch and FX-loans are thankfully not substantial any more, but weak HUF can still hurt 5/n
Most obvious channel in such a small open economy is the direct pass-through into CPI inflation, but due to high share of imported intermediate inputs it can also hurt supply (cost-push shock) - stimulative effect on exports via competitiveness is unlikely under #covid19. 6/n
Of course, collapsing aggregate demand can mitigate inflationary pressures in EMs too, but the exchange rate channel is something *extra* relative to large closed advanced economies: this sharpens (or creates) the CPI inflation-unemployment trade-off in EMs. 7/n
In the face of this trade-off the Hungarian 🇭🇺 central bank tightened monetary policy - but also loosened it! It shifted the interest rate corridor upwards, to make short HUF positions more expensive and counter HUF depreciation. But it also extended cheap liquidity to firms. 8/n
(Although the key policy rate remained unchanged, it is only symbolic in 🇭🇺. The effective interbank rate, BUBOR, is guided within the interest rate corridor with a mix of instruments, which are now pushing it upwards - also, the upper end of the corridor has been raised) 9/n
At the same time it extended its targeted cheap Funding for Lending program (similar to the ECB's TLTRO), by which banks can borrow at 0% from the CB (provided they extend loans to SME firms at most 2.5%), while they can park the corresponding liquidity at the CB at 4%! 10/n
In this dual interest rate system rates faced by firms are disconnected from the prevailing interbank rate. To incentivize banks for extending such loans, the CB in effect subsidizes them by offering a guaranteed margin of 4%. This is basically fiscal policy 11/n
The cost of these interest subsidies are born by the taxpayer (who backs CB balance sheet). Even if the subsidies can make loans to SMEs cheaper despite generally tightening monetary conditions, interest expenditures of the consolidated state (CB+gov combined) will be higher 12/n
Besides helping firms, the HUN CB also announced a QE program, in an attempt to backstop the government bond market, and prevent financing costs from going above the interbank rate. However, lowering yields on public debt further, below the now higher BUBOR, would not help 13/n
In that case, everybody would rather hold higher-yielding CB liabilities, and the consolidated state would just have swapped one of their liabilities (gov debt) to another (CB money), on which it must still pay the higher interest costs, roughly equal to BUBOR. 14/n
Of course, monetary policy could always lower the interest rate paid on its liabilities (or could "squeeze out" liquidity by quantity quotas, depressing BUBOR, along with gov bond yields) - but then HUF would weaken again: avoiding this was the very reason for the rate hike 15/n
So the consolidated state of an EM still faces a trade-off. It can fully control its borrowing costs, having unlimited liquidity in its own currency - but lowering those costs could mean a sharply weakening exchange rate, and more quickly appearing inflationary pressures. 16/n
The Hungarian CB today demonstrated this dilemma, as it in effect raised interest rates in defense of the HUF exchange rate, while other central banks are easing monetary policy. QE for gov bonds will not save the taxpayer from these higher interest costs. 17/n
At the same time, however, borrowing costs for firms and households can still be kept low via a dual interest rate system that essentially amounts to fiscal interest cost subsidies. But the same cannot be done for the consolidated government which the CB is part of. 18/18
@threader_app compile
QE can, of course, serve the purposes of yield curve control: even as the state raises short term HUF rates to discourage shorting its currency, QE could reduce rates on longer maturities, thereby flattening the yield curve.
