The Czech Crown Experiment: A Look Back

from 2013 to 2017, the Czech National Bank (CNB) implemented a controversial policy of artificially weakening the Czech crown. This intervention, known as the exchange rate commitment, pegged the crown at 27 to the euro. Jaromír Hurník, an economist with extensive experience in monetary policy, believes this move was crucial to preventing a deeper recession and deflationary spiral in the Czech Republic.

I am inherently convinced that without an exchange rate commitment, the recession in the Czech Republic would be stronger and mainly deflation would be much deeper. But most of you have no idea what would happen with the financial sector.
Jaromír Hurník, Partner at Owl

The CNB’s strategy involved printing crowns and using them to purchase foreign exchange reserves, effectively maintaining a weaker exchange rate. This 41-month commitment resulted in a ample accumulation of euros, with foreign exchange reserves reaching €141.1 billion (approximately 3.5 trillion crowns) by the end of January, representing over 40% of the country’s GDP. While the exchange rate commitment initially triggered deflation, it was intended to stimulate the economy by making Czech exports more competitive.

Navigating the Global Landscape: Consulting for Central banks

Today, Hurník leverages his expertise as a partner at Owl, a consultancy firm providing specialized services to central banks and large financial institutions worldwide. Their work focuses on two primary areas: macroeconomic forecasting and cash market operations.

Macroeconomic Forecasting: Beyond Traditional Econometrics

Many central banks, particularly in developing nations, seek assistance in developing robust macroeconomic forecasting models. Hurník points out the limitations of traditional econometric models,which often struggle to accurately predict the impact of monetary policy changes.

economics can tell you based on past correlations that inflation will move in some direction. But if you ask them what happens after raising the rate of 2 %, they say they don’t know because their models can’t do what is called “Policy Analysis”… ie modeling the Central Bank’s behavior itself. But you need this to simulate a scenario in the style of what happens if I raise or reduce interest rates.

Owl helps these institutions build models capable of “policy analysis,” allowing them to simulate the effects of various interest rate adjustments and other monetary policy decisions. These projects are frequently enough commissioned through international organizations like the World Bank,the International Monetary fund (IMF),or development agencies such as the Swiss Seco.

For example, the IMF provides technical assistance to member countries to improve their macroeconomic and financial stability. This frequently enough includes support for developing more sophisticated forecasting models.

Cash Market Operations: Building Monetary Policy Frameworks

Owl also assists countries in establishing their own monetary policy frameworks, particularly those transitioning from fixed exchange rate regimes. This involves developing the necessary infrastructure, expertise, and legal frameworks.

Hurník explains that the transition from a fixed exchange rate to an independent monetary policy is a complex undertaking. It requires not only technical expertise but also the development of dialog strategies and legal frameworks for operations like repurchase agreements (repos). Furthermore, commercial banks need to be educated on how to interact with the central bank under the new system.

The Governor’s Ambition: A Catalyst for Change?

Sometimes, the impetus for change comes from the top. Hurník notes that a central bank governor’s desire to implement independent monetary policy, similar to the Federal Reserve or the European Central Bank, can drive the demand for Owl’s services.

Sometimes their governor suddenly thinks that he also wanted to change rates like they do in Fed and other central banks. This is really done.

However, turning this ambition into reality requires significant effort and resources. It involves building internal capacity, acquiring specialized software, establishing communication channels with commercial banks, and creating a legal framework for monetary policy operations.

Beyond Central Banking: Risk Assessment for Commercial Banks

Hurník’s experience extends beyond central banking. He has also worked with commercial banks, such as the Austrian banking group Erste, on risk assessment and capital adequacy planning.

In these engagements, Owl helps banks model the impact of macroeconomic shocks, such as recessions, on their credit portfolios. This involves assessing the potential for loan defaults and determining the necessary capital reserves to maintain financial stability. Hurník notes that commercial banks often struggle with these types of macro-finance scenarios, leading them to seek specialized expertise from consulting firms.

A Niche market: Stability Through Specialization

Owl operates in a highly specialized niche market, serving a limited number of clients worldwide. Hurník emphasizes that this focus on specialized economic modeling ensures the company’s stability.

It is stable because our market is very tiny.When I overdo it, we have 10 customers around the world, mostly the international agencies I have talked about, and we do highly specialized modeling of the economy for them.

Evaluating the CNB’s Models: A Call for Broader Expertise?

With the CNB currently evaluating the effectiveness of its monetary policy, Hurník offers his perspective on the bank’s existing prediction models. He notes that the CNB’s primary model,the G3 model,has undergone numerous revisions since its inception around 2006.

While acknowledging the importance of such evaluations, Hurník suggests that the CNB’s selection of external reviewers could benefit from a broader range of expertise. He points to prominent monetary economists like Jordi Galí, Larry Christiano, and Michael Woodford as potential candidates, while recognizing the challenges of engaging such high-profile academics.

The Enduring Relevance of Economic Prediction Models

Despite criticisms, the fundamental principles behind economic prediction models have remained remarkably consistent over the past two decades.Experts suggest that the core economic theories underpinning these models haven’t seen significant innovation, with current models bearing a strong resemblance to those used in the early 2010s. This consistency raises questions about the potential for groundbreaking advancements in economic forecasting.

A Bold Experiment: The Czech National Bank’s Exchange Rate Commitment

In the mid-2010s, the Czech National Bank (CNB) embarked on a notable experiment: an exchange rate commitment. This initiative, which aimed to maintain the koruna at 27 crowns per euro, was conceived in response to interest rates hitting zero. The goal was to stimulate the economy and ward off deflation.

The Genesis of Intervention

The decision to weaken the koruna was driven by a desire to take decisive action. However, historical evidence suggests that currency interventions are fraught with risk. While the CNB had the theoretical capacity to sell crowns indefinitely,experience shows that such interventions can paradoxically strengthen the currency,undermining the intended effect. This phenomenon,observed in countries like Israel and Switzerland,highlights the challenges of manipulating currency values.

Divergent Opinions and Strategic Implementation

Initially, some advisors opposed interventions, advocating for alternative strategies like targeting price levels. However, once the decision to intervene was made, the focus shifted to ensuring its effective implementation. Drawing on academic research, particularly the work of Lars Svensson and Ben Bernanke, the CNB aimed to clearly communicate the target exchange rate and the rationale behind it. This level of transparency was unprecedented, setting a new standard for currency interventions.

Assessing the Impact of the Exchange Rate Commitment

The exchange rate commitment had a palpable impact. The CNB’s initial purchase of 7.5 billion euros stabilized the currency and provided a much-needed boost to the economy. However, challenges emerged during the exit phase, with unclear communication hindering a smooth transition. The long-term consequences of the CNB’s substantial foreign exchange reserves remain a subject of debate.

The Deflationary Threat

The threat of deflation was a significant concern. Without intervention, the Czech Republic could have faced a deeper recession and more severe deflation.Deflation’s impact on debt, as highlighted by Irving Fisher’s analysis of the great Depression, poses a serious risk to the financial sector.The CNB’s actions were aimed at mitigating these potential consequences.

Managing Massive Reserves: A New Frontier

Central banks worldwide are grappling with the challenge of managing vast reserves. The CNB, like many others, is exploring alternative investment strategies, including stocks, gold, and even cryptocurrencies like Bitcoin. This shift reflects a broader trend among central banks, particularly in Asia, to diversify their holdings and reduce reliance on traditional assets like U.S. bonds. As of early 2025,global gold reserves held by central banks reached a multi-decade high,signaling a strategic move towards hedging against economic uncertainties.

“Central banks in general… are sitting on huge reserves that they actually have no use.”

The Paradox of Reserves in a Floating Exchange Rate System

A fundamental question arises concerning the rationale behind central banks holding reserves, particularly in nations operating under a free-floating exchange rate. The very essence of a floating rate implies that intervention to manipulate or control the currency’s trajectory should be unneeded. Consequently, a central bank’s need for substantial reserves appears paradoxical. However, the reality is often more nuanced.

Discrepancies Between Policy and Practice

While many central banks proclaim adherence to a floating exchange rate policy, their actions often reveal a tendency to manage the rate within certain undisclosed bands. This covert intervention becomes evident upon closer examination of their financial data, despite official pronouncements to the contrary. This raises a critical question: are these reserves viewed as a source of stability or a potential point of failure?

The Illusion of Control and the Seeds of Crisis

The desire to maintain a currency’s value within a specific range can create what some economists term a “nominal illusion.” In a well-functioning monetary policy framework, characterized by effective inflation targeting, exchange rate fluctuations should be moderate.Major currency crises, however, are often attributed to the actions of central banks themselves, despite their tendency to blame financial markets. This perspective suggests that inconsistent monetary policy, stemming from the simultaneous pursuit of exchange rate stability and interest rate control, is a primary catalyst for currency crises.

Every currency crisis begins in the Governor’s office.

Central Bank Actions and the Specter of financial Instability

Historical analysis suggests that central bank missteps have played a significant role in triggering financial crises.The pursuit of conflicting objectives, such as maintaining a specific exchange rate while concurrently managing interest rates, creates inherent instability. This inherent contradiction is frequently enough the genesis of currency crises,highlighting the immense obligation and potential impact of central bank policies on global financial stability. Such as, the Asian Financial Crisis of 1997, while complex, involved fixed exchange rate regimes that ultimately proved unsustainable under market pressure.

The Role of Central Banks in Economic Stability

Central banks play a crucial role in maintaining financial and economic stability by managing the money supply and adjusting interest rates [1], [3]. They are centralized financial institutions responsible for economic and monetary policy [2], [3]. However, the effectiveness of these tools depends on consistent and well-coordinated policies.