Session 2: Responses to monetary policy and financial shocks
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Boone, Laurence
Mihaljek, Dubravko
Isărescu, Mugur Constantin
Radev, Dimitar
Vincelette, Gallina A.
Ilahi, Nadeem
The global financial landscape is changing, and financial conditions have tightened: How is the path towards normalisation of the monetary policies of the Federal Reserve System and, prospectively, the European Central Bank (ECB) influencing financial conditions and monetary policies in the CESEE countries? What have been the major spillovers from changing global financial conditions? How have they differed depending on the different monetary policy frameworks and exchange rate regimes in place? Is there any dissimilarity, in terms of impact on the region, between the policies of the Federal Reserve System and the ECB? What is the impact on capital flows to the region? What are the potential implications for economic growth and for the paths towards euro adoption? What are the prospects for further financial development in the region? What are the resulting policy challenges and what options do CESEE countries have in order to address them?
 So let me give 30 seconds to for those of you who still stand to sit down if you wish. You can also listen standing, it's okay. So good afternoon, let me open the second session on our responses to monetary policy and financial shocks. We have a wonderful lineup to set the stage and start a discussion. I would like to thank speakers for joining first and foremost and also to invite them to be concise so that we can have time for a broader discussion with the audience. I would also like to invite you to not to feel too much constraint in the presentations and discussion. That is the session being titled responses to monetary policy and financial shocks. That could be a very narrow way to look at the discussion which would be to focus on spillovers from ECB monetary policy and spillovers from US monetary policy and how CZ countries have reacted to that. And that certainly will be the core of the discussion but we also have an opportunity to discuss macro-prudential frameworks, financial resilience which is very much part of what both President Draghi and the IMF MD have discussed this morning. So I would really encourage you to broaden the discussion to all aspects of resilience in the macro and financial field. And last but not least, it's good to be in a conference where it's not all about trade. So we have a group, we have an opportunity to show that it's not all about trade. And I'm sure it will be exciting. So let me open the presentations with the first keynote speaker, Laurence Boone, Chief Economist of the OECD. Thank you. Thank you Benoit for this very nice introduction. I will unfortunately start by being a little narrow because in this presentation I will focus mostly on spillovers from the ECB but I will not talk only about monetary policy so hopefully it will open the door to the question that you want to raise afterwards. Today I would like to discuss the macro framework in fact and the main message I would like to leave you with is has to do with three points. The first one is that also the exchange rate regime is generally floating for most easy countries and they have strived to achieve stable inflation and stable financial condition but while showing preferences for minimizing exchange rate fluctuation in a number of them. And within this framework as long as the business cycle is in harmony with the emu aggregate with the euro area then the framework appears to function quite well. However, over the recent period especially because most easy countries have rebounded and recovered from the crisis much better than the euro area and inflationary pressure are building up which is a sharp contrast to the euro zone then this type of framework may create tension between monetary policy, financial condition and economic stability. And so that drives me to my third point which actually and we haven't talked to each other but is related to what Benoit was saying that there are other policy tools to consider when we're looking at the macro policy framework. There's prudential and supervision on the one hand and there is fiscal as well on the other hand. And what I would insist on here is that the presentation will suggest that fiscal policy may have been prosyclical and contributed to fuel the acceleration of the season in comparison with euro area which would argue for a more balanced policy mix with tighter fiscal policy to moderate the business cycle and that would allow central banks to actually have a more gradual monetary policy tightening and therefore exchange rate appreciation. And obviously that's assuming that trade tensions do not escalate but that was this morning discussion. So what I will do today is I will first recall rapidly what the theoretical channels for monetary policy transmission and financial policy transmission are through trade, through finance and then I will show you some empirical work which we have done at the OECD to assess the strengths of these channels and then come back to the conclusion. So there are two categories of channels which can shape spillover as you know from the euro area to CZ countries. Trade and finance. We've discussed extensively trade this morning so what I will do here is simply focus on how your area monetary policy can affect the CZ GDP and inflation through trade. And there are two main channels. As you know the first one is the income effect so if the euro area loses monetary policy then it increases demand for non-euro areas, economies exports of goods and services. This in turn tends to boost those economies output and it creates commovements with the euro area output. But then there might be a second effect which is an expenditure switching effect. So under a flexible exchange rate regime when the euro area monetary policy becomes more accommodative this is the exchange rate should appreciate unless monetary policy will respond one for one. And in turn the exchange rate appreciation should mitigate the increase in exports from the income effect. All together the combined effect will depend on the elasticity of substitution and the degree of openness which we discussed extensively this morning and the extent to which the countries are actually integrated into the euro area value chain. But what I would like to focus on which is why we have this chart here is at least for these three or CZ countries even so the euro area we have floating exchange rate regime in practice. And this is not only relevant for the Czech Republic, Hungary and Poland but in practice most CZ countries have shown preference for limiting exchange rate fluctuation vis-à-vis the euro. And in addition what you can see from this chart is that most of the export of CZ countries to non-euro countries like to your countries obviously given the importance of value chains across Europe are actually invoiced in euro or actually it's more invoiced in euro for export than when you compare to other countries and for import it's slightly different because we have a commodity effect here. So if we add all this together we're probably not really under a floating exchange rate regime and we could anticipate that the income effect should dominate and the transmission of euro area GDP fluctuation or monetary policy impact on GDP fluctuation should impact the CZ countries in about the same way. And before I move to the financial linkage perhaps just a snapshot on inflation where here we expect that inflation fluctuation are not so much reflecting what's happening in the euro area because of the importance of commodity and prices, energy and food, energy which will tend to be invoiced in dollars and also because over the recent period there has been some countries specific in geosyncratic shocks like a lot of indirect taxes, employer social security contributions and statutory minimum wage movement in some of the CZ countries. So that's for the trade effect. Now let me move to the financial one. So financial integration of economies can be reflected through three main channels. One is portfolio holdings. The second will be non-financial sector, boring and the third will be cross-border banking. And what you see here is the stock of portfolio liabilities and what we wanted to show with this chart is when you compare CZ countries with other neighboring countries of the euro area which are in the EU for example, then you can see that the role of the euro is much more important for CZ countries in terms of portfolio liabilities than for the others. So in theory more accommodative ECB and I'm saying accommodative because it's to take an example obviously not because I take a stance on this can affect financially CZ countries through the three channels. The first one will be the substitutability between EMU and CZ assets in portfolio. So if we abstract from safe heaven effects then lower euro area interest rates should put pressure on CZ interest rates as investors search for yield. And indeed we have observed that in this presentation which will be on the web in the annex you have a chart with short term and long term interest rates and you can see that whether countries in Central and Eastern Europe were close to the zero lower bound or not, interest rates movement from the euro have impacted interest rates in the CZ countries and when they were close to the zero lower bound the spread has been compressed as well. So overall when we have loser financial condition from this channel in the euro zone then it translates into loser financial condition in CZ countries. The second channel is the balance sheet channel which you know well and that relates to the one of the point that Benoit Curre was leading to which is that to the extent CZ liabilities are in euros while the assets may be in local currency then more accommodative euro monetary policy should generate positive valuation effect. In fact when we look at the evolution and what happened in CZ countries since the financial crisis I think this channel is perhaps less prevalent than it used to because the stock of euro denominated loans to the non-financial private sector has been falling significantly in the wake of the crisis and in particular for households in some countries. And again there's a chart in the annex that shows that quite clearly. And then last but not least there is the third channel which is cross border bank lending. Obviously if we have more accommodative lending condition in banks in euro area countries or from euro area countries supplying loans to CZ countries then that should support credit bank credit to CZ countries. So together if we add all these channels with relatively stable exchange rates more accommodative monetary condition in the euro area is expected to translate into more accommodative condition in CZ countries both directly through the movement of emu and CZ interest rates but also indirectly because it improves the domestic funding condition. And I think when we add the trade channel and the financial channel then we can expect really a strong impact from the euro area monetary policy. So let me now turn to what we have found empirically and I will present the results of two way of looking at this which are pretty much in line with what the literature in this area has suggested. And basically what our empirical analysis confirms the importance of these two transmission channel. So first we've used a very simple factor model analysis which breaks the contribution to the variance of financial variables and also unreal variable into global, regional, regional being European and country specific factors. And what you can see here is that we are seeing a strong influence from the regional channel so the European channel on the movement in the tenured government bond yield compared with the other channel whether it's global or it's country specific. And you have three CZ countries, Hungary, the Czech Republic and Poland on the right hand side and the red block which is the European contribution is much larger than for any of the other area that we look at whether it's non-EU or EU countries. We've done that for equity prices as well and you find the same phenomenon where the European component is much larger than the global or the country specific component. It's quite interesting to see that in Norway and the UK for example the country specific component is very, very significant. And then we've also done this decomposition for inflation and like as I discussed earlier the results are very in line with what we should expect meaning that this time the three OECD CZ countries are much more sensitive to the global condition and that's the role of commodity prices than they are to the European factor. But even there what we can see is that the European element is still playing a significant role but not bigger than for other EU neighboring countries. And finally we do this decomposition for GDP growth and here as well what we can see is a strong predominance of the European factor. And I think this reflects quite well the discussion that we had this morning on trade which is how open and integrated into the value chain the CZ countries are even if here we focus only on three of them. So that's a very simple nearly descriptive analysis. It provides evidence of co-movements but it doesn't really look at the spillovers. It's just showing the share of which factor. So what we've done in another exercise is actually have a large scale Bayesian var models to gauge the main transmission mechanism of the spillover and here I'm only showing the Czech Republic but we have similar results for Hungary and Poland. And it's once again confirming what we were when I was discussing in the first part of this speech which is the importance of the European factor for the CZ countries. What you can see clearly is if the eurozone lower interest rates by one standard deviation then we have the same type of shock on the interest rate that's the left-hand side chart then it vanishes as GDP which is on the right-hand side chart actually increases and equity prices move a lot more as would be expected from this type of exercise. I have not we have not represented here the exchange rate channel because it was insignificant which is indeed what we would expect if the exchange rate was pretty much stable over the period. And again these results hold for Hungary and Poland as well. So I think when we look at the short and limited empirical evidence that I present here this is in line with what we know of the classic Monday flaming trial and mark. So CZ countries have free capital flows with the euro area so if they wish to pursue stable exchange rates then monetary policy is not really autonomous. And this is fine when the two regions are moving in a synchronized way but it's much more complex obviously when the business cycle diverges. And when we look at the most recent period since the crisis the recovery has accelerated faster in CZ countries than in the euro area and inflation has recovered closer to the target so that the high degree of monetary transmission may have actually contributed to two accommodative or more accommodative monetary policy in the CZ region that were wanted by domestic condition. And what I want to show you here it's over the period 2015-2018 some charts that I find really really striking because they compare the last three years that's the red dots with the period before which is 2007-2014 and you look at the movement in interest rate compared with inflation and you can see that the blue dot which is the previous period seems much more in a way tighter or if you look at the red dot you can see that it has taken much more time and sometimes it hasn't even happened yet for our short term interest rate to go up in spite of the inflationary condition. There's a difference which is clearly visible for example between the Czech Republic and Poland if you look at the Czech Republic monetary policy looks on this chart accommodative for a while and over the most recent period then there has been a high interest rate so we're converging towards the blue line and the former relationship that we had but when we look at Poland we can see that we're way below what would have been the case for this inflation in the previous period. So I quite like this chart because I think they contrast very well how monetary policy looks much more accommodative over the past three years than what it had been before for similar inflation. And I would like to conclude here it's actually I'm going to try and move into the annex if I have the time for one minute. Okay well I want to show you here is the fiscal stance because we have on the one hand monetary policy which looks very very accommodative and on the other hand and that's just for a short period but we could take it a little more what we can see here is we have a very stimulating fiscal policy either in 2018 or 2019 for Poland in spite of the fact that economic growth is very high and that inflation is picking up and I don't think I've put them here but when you look at unit labour costs in these regions they have increased very very fast and they have squeezed profit margin and we can expect them to actually translate into inflation quite soon. So let me go back on well actually since I'm here you can see the interest rate movement I was mentioning earlier. So to conclude and before I get stopped by the chair of the meeting let me leave you with these three points first I think if if pursuing a stable exchange rate with the euro so that there is strong monetary policy transmission from EMU then CC countries may have little room for maneuver with monetary tools and this can be an issue when the business cycle appears to synchronize and the imported monetary policies not really appropriate for domestic condition. So some would say that this could suggest that domestic central banks should react more forcefully to the domestic condition and let the exchange rate appreciate. But what I would like to argue and that's why I showed the last slide is there's no reason to put all the burden of the adjustment on the shoulder of central banks. What you could see in the previous slide is fiscal policy has been and is being prosyclical in some countries which together with sizable EU structural fund flows because that provides you to buffer may have contributed to fuel economic activity more than was necessary given the strengths of the recovery. So it's the overall policy mix which may have been too supportive given the brisk economic momentum. And I think to the extent that the policy mix may create domestic imbalances and I was mentioning the sharp appreciation of unit labor costs for example then there may be some scope to use fiscal policy in a more counter-synclical way that is to tighten fiscal policy which would allow central banks to actually tighten their monetary policy more gradually and with less exchange rate appreciation. Obviously all these to the carriers that trade tension do not increase. And the one last thing is I think the financial condition of all the countries was very different which is why I didn't get into this. But when we looked at it some countries have really also taken very significant macro prudential measures and I'm thinking for example of the Czech Republic but in other countries this transmission of monetary policy has also financial implication and their scope to discuss supervisory and prudential policy as well. Thank you. Thank you very much, Lohan. This sets the stage very nicely and also makes for a good transition with the discussion this morning. You've also shown how trade structures shape the sensitivity to external shocks also in the macro and the financial field. So I guess the punchline is that it is a vindication of the Moundel dilemma but there are also elements of a dilemma in your presentation because you also show how much the for instance long-term bond yields have been also impacted by ECB policies. So there is a global financial cycle, a regional financial cycle also which interferes with these decisions. So I guess we'll have time to discuss it further and without due delay I give the floor to Dubravko Mihalyek from the Bank Financial Settlements. Thank you, Mr. Kure. Good afternoon, everyone. Thank you. Thanks to the organizer for this opportunity. I would like to extend a bit the discussion so far. We've been talking about transmission of real shocks, then financial and monetary shocks from EU to this region. I would like to talk a bit about transmission of global financial conditions to the region. So let me start with this chart which is showing global purchasing managers indices for manufacturing and services in the left-hand panel. The upshot is that the global economy is slowing. You see the green line in the left-hand panel below 50. So this means purchasing managers around the world are ordering less and the activity is no longer expanding. It's contracting. And then on the right-hand panel you see further explanation of what's happening. Global trade is no longer expanding. There has been this steep drop late last year, early this year. And then in particular, the blue line, the new export orders, you see no longer expanding. They are contracting. But interestingly, what's happening is that at the same time manufacturing is contracting. Employment is still relatively strong and the capacity utilization has been for a while holding up. Left-hand panel, in the center panel you see that consumption is holding up well. PMIs that describe consumer goods and services purchases are still in the positive expansion territory. However what's not so good for the outlook is that investment has weakened considerably. When you look at the right-hand panel, these are subcomponents of PMIs for industrial goods, for machinery and equipment, for electronic computing equipment. All these at the global level are currently in the contraction territory. So what is happening? We know there are trade tensions. We know there are political uncertainties. And the region, Central Eastern, South Eastern Europe, has been affected through global value chains, what we heard this morning, notably German manufacturing. And reflecting these developments and below inflation outcomes, monetary policy is no longer tightening. In draft program for this conference was first circulated in December of last year. Monetary policy normalization in the US was underway for three years. And in the Euro area, ECB was taking initial steps towards normalization by ending net bond purchases. Now against this backdrop of global slowdown, monetary tightening is no longer imminent. So where could this change in financial conditions come from? Presumably it could come through a rise in risk premia. With still weaker trade outlook and political uncertainties, business and investor sentiment could be dentined and risk spreads could widen. You can see, for instance, that they have already widened for corporate bonds and for emerging market bonds. A particular concern is further strengthening of the dollar. There is a fairly large body of literature which documents an empirical relationship between the strength of the dollar and global financing conditions. If you look at graph seven left hand panel, you see that there is an interesting relationship with when the dollar nominal effective exchange rate weakens, financing conditions ease globally, and more credit is flowing to emerging market firms. And vice versa, when the dollar strengthens, as has happened over the past year and earlier this year, this means tighter financing conditions and less credit flowing to EMEs. So we've heard a bit about the economics behind this relationship. On the supply side, credit worthiness of borrowers improves as dollar denominated liabilities fall relative to domestic assets. This reduces tail risk in banks, credit portfolios, relaxes value at risk or economic capital constraints, and creates capacity for additional lending. On the demand side, balance sheets of firms that borrow in dollars strengthen when dollar liabilities decline in domestic currency terms, and this may encourage more borrowing in dollars. So these are some of the familiar relationships. However, what is not widely known is that this, the broad dollar index, nominal effective exchange rate of the dollar also tracks closely changes in global manufacturing activity measured by PMIs. As you can see in the right-hand panel here, there is again an interesting relationship between PMIs for global manufacturing, which tend to weaken when the dollar strengthens. And what's more interesting is that this relationship holds not just for advanced, for emerging market economies, as you would expect, but also for advanced economies. As this graph shows on the left-hand panel, we have PMIs for Germany, Italy, and Austria, and the black solid line is the dollar nominal effective exchange rate. You see fairly close inverse relationship. Right-hand panel shows the same for Czech Republic and Poland. So this is a bit surprising for Europe, because we take it for granted that the euro, not the dollar, sets financing conditions for the real sector in Europe. This association between the dollar and real activity is, of course, a correlation. It's not a causation. But it's unlikely to be coincidental. It could reflect so-called working capital channel of trade fluctuations. And this working capital channel features on one hand global value chains, and on the other hand, prevalence of dollar in voicing in global trade. And the upshot of interaction of these two themes is that stronger dollar, as we can see indeed from these graphs, is associated with tighter credit conditions for financing working capital. We don't know how strong this working capital channel is in Central and Eastern Europe. But we know what we heard earlier that Central Eastern Europe is highly integrated with euro, area, real, and financial sectors. So this enables us to use insights from models of monetary and financial spillovers via internationally active banks. What this literature tells us is that for domestic transmission of shocks, the key issue is understanding heterogeneity in individual banks' responses to domestic monetary shocks. And for international transmission, similarly, we also have to look at global banks' cross-country responses to monetary shocks. So what we've talked so far about is mainly a case of borrower and lender countries. But what if the bulk of cross-border lending is denominated in a third global currency? Multinational banking groups raise funding and extend credit in a range of currency. On behalf of BIS, reporting banks, cross-border assets and liabilities are denominated in dollars, and about a third are in euros. So this means that monetary policy of a third country, neither the lenders nor the borrowers may also come into play in cross-border lending spillovers. Recent examples are what we are showing here, what we have just shown before, US dollar, and hence FEDS monetary policy. A case that is familiar to Central Eastern Europe is Swiss Franc and SMB monetary policy few years ago. So recent work at the BIS has shown that indeed all three monetary policy, lender countries, borrower countries, and then currency of denomination country monetary policy can all play a role in these cross-border spillovers. And again, the strength of transmission of these channels depends on frictions that banks face and borrowers face. So it's more a question of micro level, bank level situation that determines how strong is the transmission of spillovers. One study that I think is of some interest to countries in this region is the one done by Hayek and Horvat who examined specifically shocks from Euro area in the US and how they affect economic activity and prices in non-EU countries, non-Euro EU countries, Bulgaria, Croatia, Czech Republic, Denmark, Hungary, Poland, Romania, Sweden, and UK. And to see in this graph are responses of industrial production to 100 basis point increase in the ECB shadow policy rate by country over 12, 18, and 24 month periods from the model estimated by Hayek and Horvat. And you can see from these dots that on average industrial production growth falls by about 0.5 percentage points for 100 basis point increase in shadow policy rate. The response to Fed's shadow policy rate increase is somewhat smaller, but it's also statistically significant. So what do we make from this? What kind of policy responses to financial shocks can we think of in countries in central and eastern Europe? Overall I think there is now a body of evidence which shows that real activity in central eastern Europe is quite sensitive to changes in global financial conditions. So one implication straightforward is the need to monitor how these conditions evolve and how they spill over to the domestic economy through bank and non-bank credit. When you look back to last year and early this year, financing conditions in the region have tightened slightly. This is based on EIB landing survey for the region. Funding conditions for international banking groups active in the region were easing last year supported by the growth of deposits and collateral requirements were also easing. However, longer term funding conditions have not eased. And this resulted in a gap between demand for credit on the part of firms, especially for working capital and supply of credit. So if global financial conditions were to tighten further this year, firms access to finance could become a constraint to growth. What sort of responses could we then think of? I think one channel of transmission that is important but is not often considered at length is that of credit constrained firms, especially SMEs. This morning Deborah mentioned this channel. In small firms are also financially more opaque and their owners often have to use housing equity as collateral for firm credit. This implies that changes in domestic policy rates and macro-potential regulations can have pronounced effects on SME activity in some countries. Some work that my colleagues have done at the BIS with firm level data show that indeed these collateral lending channel can be economically important. For instance, in Spain and Italy, a one percentage point change in the growth of collateral values induces a percentage point change in liabilities of SMEs and a similarly sized change in their investment. We are talking here about firms with less than half a million in total assets. And furthermore, these changes in collateral values mostly affect employment in young firms, less than five years old. Other firms are able to grow employment from current revenues rather than bank borrowing. So since in central and Eastern Europe access to bank credit is likely to be more constrained than in Italy and Spain given the relative state of development of their banking systems and legal frameworks, especially data aspects governing recourse, loan enforcement and bankruptcy resolution, I think monetary policy potentially can have important effects through collateral value and this balance sheet channel. I will stop there. Thank you. Thank you very much, D'Wafco. There was a fascinating difference of perspectives in the two presentations with Lawrence focusing very much on our CZ countries as neighbors of the ECB and EMU and you, D'Wafco, focusing on the global, taking the global perspective. And of course both are important. So it's really the two sides of the same discussion. And I would really like if we could spend a little bit of time later on discussing the banking channels which you've started to introduce in our discussion. It's a key policy question for us as ECB and as Eurozone that we take into consideration not only spillovers and spillbacks from EMU and into EMU as a monetary union but also as a banking union. And so the cynical view would be it doesn't matter so much because we are in incomplete banking union anyway and our home host issues also inside EMU. So maybe it doesn't matter so much whether you're inside EMU or outside EMU because there are home host issues everywhere. But if we can progress towards what is our objective to have a single banking area inside EMU, then the issue will arise as to which kind of spillovers we create for countries outside of EMU. And this will be very important for the transmission of shocks. So thank you for introducing that dimension. Let me, so we now have four panelists and the first panelist is Mugur Irisarescu Garno of the National Bank of Romania. Mugur, thank you for joining. Thank you, Mugur. I like to make three short comments in my limited time. One is about our topic. One is a general one, general comment. The other two will be related to the view from inflation target our position. The first general one is what could we understand about the monetary policy normalization that generally meaning is or broadly speaking is a policy normalization which implies two process. The first one is the withdrawal of unconventional instruments. You start at the outbreak of the global crisis. It's clear this is a difficult and lengthy process which involves adjusting the balance sheet of the central banks, particularly in the large central banks. The influence on the global asset prices. The second process is the increase in the short term interest rates. This is equally intricate one, taking into account its effects on financial stability and the current relatively high endemnness all across the world, particularly in some countries in the European Union. Then if you were supposed to ask me two months ago what is the policy normalization, I was supposed to say that the question is not when, is not if this is going to happen, but when it's going to happen. Now, as you've already said and you said before me, and it's good that you said before me, it's going not to be imminent, this kind of policy normalization, particularly related to the increase in the policy rates. Let me say that it is debatable if the forthcoming normalization process involves going back to the pre-crisis normal or we are going to have a new normal which will be characterized by lower interest rate and possible by larger central bank balance sheets which will be for a pretty longer period of time. If you ask me now, I'm biased to say that perhaps a new normal is going to happen, but this is only a comment I have. Regarding the other two comments, that will be from the position of the National Bank of Romania which is an inflation targetter, that we are exactly like Poland, Czech Republic and Hungary central banks, inflation targetter. Since 2005, we define from the very beginning that we are considering and we consider light inflation targeting. For example, we never accepted to have a free floating because of sensitivity of exchange rate movement in the Romanian economy. We had the managed floating for example, but in the meantime it was changed. What is happening is that we remain loyal to the inflation targeting, but the inflation targeting is no longer loyal to us. It was so many changes into the inflation targeting framework that particularly in the last several years is something like a different framework. I will say only two words about two underlying principles. One is that after the outbreak of the global crisis and in the post-crisis development, that it was a departure from the old orthodoxy particularly on the exchange rate policy. For example, before the crisis, Forex interventions were more or less considered to be damped. It's not good now. It was Czech central bank which started with this. It was going somewhere to a full commitment to, for a period it's true, since 2013 to 2017 to have exchange rate commitment and to intervene with our time or volume limits to prevent the appreciation of the corona. I quote what the Czech central bank said. We're not in this position, but we did intervene in the Forex market to alleviate the large fluctuations of the Forex and particularly to discourage Forex credit, which we discovered that is undermining the monetary policy. We are targeting, for example, monetary policy to curb inflation, but the aggregate demand was rampant, was increasing via Forex credit, which was very dangerous. In this respect, I found that also the general manager of BIS, Augustine Carstens, said that this is a general trend in all the emerging markets, not only in the European central and Eastern European countries with inflation targeting, to have a new definition of inflation targeting, which is based more on the intervention of the Forex market. The second is with the macro-pudential tools, which were now clearly a part of inflation targeting. I could say that inflation targeting is no longer so clean as it was 10 years ago, and perhaps is for better because the central banks have now more, to say, not mandates, more goals to achieve. It's also related to financial stability. We ask from time to time not to discourage economic growth. We are under populist attack. That's not only in the Eastern Europe, also in South Eastern Europe, I have seen in the central Europe. The second or the third comment is related to the policy rate, what is the central bank in our area doing with the policy rate? What is the situation? The classic recipe for inflation targeting was to recommend a policy rate hike when the inflation was moving up, and to have positive policy rate and generally positive money market rates. However, if you look to all the countries like inflation target, Czech Republic, Poland, and Hungary, and also Romania, we have no negative interest rates, and our policy rate is below the inflation. We increased three times in Romania the policy rate last year, but to stop, why? Because for example, in Romania, inflation is around 4%. Policy rate is 2.5% in Hungary, is also around 4%, 3.9%, and inflation. The policy rate is 0.9%. We discovered that we are moving only in this direction. There are the danger of having capital inflows to appreciate the currency, and we have a problem of balance of payment. We have a current account deficit. And we have to be very careful to this movement. We prefer, for example, to tighten money conditions through, let's say, liquidity control domestically, and not to increase the policy rate and to have more flexibility. But I couldn't say this is the good advice to the others. It was the kind of innovation because I discovered, and we discovered there are a lot of innovations, not only in Romania, all around the world. And looking forward, and now I'm going to read because we don't have oral guidance, and regarding the future, I like to be constructive ambiguity, what we are going to do. Looking forward, the National Bank of Romania future policy actions will definitely depend on the way monetary policy normalization unfolds in Europe. What happened in the emerging economies, for example, that are part of the US dollar sphere influence following the Fed's policy normalization is quite relevant. Higher interest rates developed toward in the US would trigger a capital flight away from emerging economies, thus generating depreciation pressures. The response of policymakers in emerging economies will depend on the specific strengths and weaknesses where adequate policy buffers are in place and investor confidence is elevated. Market mechanism, counter cyclical, macroeconomic and prudential policy may be relied upon to tackle a slowdown in capital inflows. Where is the less room for maneuvering, tight and monetary and fiscal policy, policies may be required to lower financing needs and attract additional inflows. Where foreign reserves are adequate, they may be used to moderate or musn exchange rate depreciation. Which a versa if the situation in Europe will remain with a pretty low or quite negative interest rates, for inflation target I guesstimate will be very difficult to increase policy rates and money market rates. Otherwise, there is the danger of exchange rate appreciation which first reaction is, this is good for inflation going down, but if you have as is the remaining case, if you have a problem with the current account deficit, this is only worsening the situation and only postponement of the problems. Then let me to say a conclusion. It follows that when the normalization wave hits, the magnitude of the impact will depend on how vulnerable emerging economies when our countries consider central and eastern and south eastern Europe like emerging economies or of course, share republic is not, are to external financing. A contained current account deficit, a long average maturity on public and private foreign currency debt and coherent mix of counter-cyclical macroeconomic policies and structural reforms would go a long way in limiting the risks. If proper economic policy actions are not implemented while there is a window of opportunity, the possibility of a forced resort in a more or less distant future to the suboptimal and improvised measures in the face of adversity cannot be ruled out. To sum up, keeping domestic and external imbalances in check is long way our countries will be able to cope with any strong volatility headwinds. This is not difficult to be said in wording. It's much more difficult to be put in practice, particularly when there are elections years like we have now in Romania this year and next year. Thank you very much. Thank you very much, Mugu. Well, since you were wondering, I think the working assumption that monetary policy tightening in the eurozone is not immediate is a relevant assumption for our discussion. So Dimitar, please, the floor is yours. Thank you. Thank you, Beno. I will focus on the transmission of ECB monetary policy to the region as I was asked from the country-specific perspective of Bulgaria. My understanding is Galina and Nadine will look at it from the regional angle. I will say a few words about the transmission of the ECB policy. After that, I will shortly refer to the policy response to the changing monetary conditions and finally I will say a few words about the macro-prudential measures that we introduced to address the related financial stability risks. Needless to say, the ECB's monetary policy plays an important role for economic activity in the region due to, as was mentioned several times, to the high openness of the economy and their strong trade and financial links with the euro area. Recent empirical studies point to spillover effects from ECB's monetary policy to non-euro area, EU economies, irrespective of the exchange rate regime. Depending on the specific structural features of the economies, however, the strength of the transmission can vary across countries. For Bulgaria, the key features that determine the direct transmission of ECB's monetary policy are related to the country's currency-ball arrangement with fixed exchange rate of the national currency against the euro and the country's strong trade and financial integration with the euro area. Under the currency-ball arrangements, domestic monetary conditions are largely determined by the monetary environment in the euro area. The chart that you can see illustrates the parallel dynamics, respectively, of the left and euro area overnight index averages. An additional prerequisite for a strong pass-through of ECB's monetary policy to the domestic banking system is the dominant role of the euro area on banks in the Bulgaria banking sector. At the same time, around 50% of exports are distinct to the euro area, and the euro area investors account for 67% of the stock of FDIs. The effects of the direct transmission of ECB's policy measures since mid-2014 could be illustrated with the high liquidity of the banking sector and the sustained decline over the period in interbank money market interest rates and in interest rates on deposits and loans against the background of strengthening macroeconomic conditions. As for the channels of transmission, our research suggests that the effects of ECB's monetary policy changes are transmitted to Bulgaria's economic activity mainly through the foreign trade channel. The effects from the change in interest rates and asset prices represented in this research by residential property prices take more time to materialize and affect economic activity to a lesser extent compared to the trade channel. A few words on our policy responses to 2016. Just to give you a flavor, I'll focus on one policy action with regard to the bank reserves, and accounts with the BNB. Given our monetary framework, the ECB's decision to introduce a negative interest rate in its deposit facility in June 2014 led banks operating in Bulgaria to start holding excess reserves in their accounts with the central bank since the interest rate and excess reserves at that time were zero. As a result, the 10-2015 bank deposits with the central bank in excess of the minimum required reserves reached almost 130 percent on average daily basis. To address these developments, we changed in 2016 our policy with respect to the required reserves of banks. We introduced a definition of excess reserves for bank accounts held with the BNB and introduced the interest rate on the deposit facility of the ECB to be applied under excess reserves when this interest rate is negative. Zero interest rate is applied on excess reserves when the ECB deposit facility rate is positive for zero. The changes led to a strength, these changes in fact led to a strength and propagation of ECB's interest rates to the Bulgarian economy. Bank success reserves however remain sizable. That is why as from October 2017 the central bank introduced an extra minus 20 basis points at top of the ECB deposit facility interest rate with which bank success reserves held that the BNB are charged. As a result, there has been downward trend in excess reserves from about 56 percent in October 2017 to about 26 percent of minimum required reserves on average daily basis in April 2019. Should illustrate this with the next chart which gives an idea about the changes in our bank reserves and excess reserves along with the ECB deposit facility rate. Finally, a few words about the financial stability implications that in my view are very, very important. The prolonged period of accommodative monetary policy of the ECB has helped the recovery of economic activity throughout the EU but it has also increased the potential of buildup of financial stability risks. In the Sezy countries and in Bulgaria more specifically the favorable financing conditions improving macroeconomic environment and high liquidity in the banking system have stimulated credit activity while at the same time residential property prices have been increasing at relatively high rates. To limit potential risks we did mainly two things. First, we strengthened our macro prudential framework and second, we activated the counter cyclical capital buffer. The key element of strengthening macro prudential powers of the central bank was the establishment in 2018 of the legislative basis for borrower based measures requirements such as LTVLTI in addition to the existing capital based measures. As for the activation of the counter cyclical capital buffer we took two decisions so far. First in 2018 we set the counter cyclical capital buffer rate applicable to credit risk exposures in Bulgaria at 0.5% in effect from October 1st, 2019 and second early this year we further increased the rate to 1% in effect from April 1st, 2020. It's probably important to say that the rate is applied to the overall credit stock of banks and not to the volume of newly issued loans. It was also announced that the central bank could increase the rate to a higher level earlier in the event of a significant acceleration of credit growth. These decisions were taken despite the fact that the standard metric for deviation of the credit to GDP ratio from its long-term trend remained deeply in negative territory. This estimation however is sensitive to the time series sample and cannot provide timely indication about turning points. Therefore the decision for the increase of the counter cyclical capital buffer rate were taken considering the relatively high growth rate of credit as well as on the basis of an in-depth analysis of the financial cycle. The chart, the last chart that I have in fact displays our aggregate measure of the financial cycle. It can be seen that in 2017 the economy was entering the initial phase of cyclical risk accumulation. To wrap up, I would like to emphasize the following points. First, the monetary policy of the ECB plays an important role for economic activity in the region because of the high openness of the economies and their strong trade and financial links with the Euro area. For in Bulgaria the currency bought on edgements lead to a direct transmission of the ECB's monetary policy to the economy. Second, the substantial monetary policy stimulus provided by the ECB through its non-standard monetary policy measures has contributed to strengthening the monetary policy transmission to the region. The BNB has introduced changes to its policy with respect to the required reserves of banks which have led to faster and stronger propagation of the ECB interest rates to the Bulgarian economy. And finally, the prolonged period of accumulative monetary policy of the ECB and the spillover effects to the region create potential financial stability risks that need to be addressed with adequate macro-prudential measures, including by strengthening the macro-prudential powers of relevant authorities, the central bank in our case, and activating the counter-cyclical capital buffers. And I'll stop here. Thank you. Thank you very much, Dimita. Of course this becomes even more important now than the Bulgarian has a clear perspective to join both the exchange rate mechanism and the banking union. So that's your unique in that perspective compared to the neighboring countries. So we're now going to conclude by with broadening of the discussion with the views of the World Bank and the IMF. So let me give the floor to Gellina Vincelet for the World Bank. Thank you very much, Chair, and thank you for inviting me to speak here at this conference today. I will indeed a little bit broaden the discussion, but at the same time focus it on the six Western Balkan countries. And I'll change a little bit my remarks as previous speakers did very eloquently explain the transmission channels through which eventual normalization or a financial condition change could affect the countries of the Western Balkans. Instead I would like us to think about what are the conditions in these six countries should an eventual shock arrive. So I'll focus on the public sector, the private sector, and then think about what policymakers can do today. Starting with the public sector, last few years we have seen a significant improvement in fiscal positions of the six Western Balkan countries. This being said, public debt remains still at relatively high levels. Countries like Montenegro and Albania have public and publicly guaranteed debt which stands at 70 or above percent of GDP. North Macedonia and Serbia are hovering around the 50 percent mark as well. Moreover, and importantly, public debt is with a significant external component which means that for example in Montenegro or in Serbia significant part of the debt is external. And this is quite important. Several of the Western Balkan countries also are running elevated external and domestic imbalances. So this taken together would imply that a higher interest rate spending could crowd out productive spending in infrastructure as well as social spending. It could also pose challenges for rollover of external debt and may become more costly. And the dependence on these countries on foreign financing. For the private sector, and given the global investment decline as Dubrovko showed us very nicely in the chart, that would mean that there is a real threat of reducing private investment rates in the countries. At the end of 2018, private investment for the region stood at about 18 percent. And this is not high. This is for these countries to really ignite growth and to reignite convergence, investment rates will need to be significantly higher. Capital needs to deepen more. Moreover, private investment in some of the countries continues to grow at rates slower than the rates of growth of the economy. This means that investment is shrinking as a share of economic activity. I'll give you the example of Serbia here, where in 2018 last year, growth of private investment was 2.5 percent compared to economic growth of 4.2 percent. If we take a little bit of a longer perspective of the last decade, we see that private investment has practically stagnated in this country. Looking at foreign direct investment, again, FDI in the region remains low. It is at about 5.5 percent of GDP today. Again, you know, has come down significantly after the global financial crisis. But what is important about FDI, it's weak structure. What I mean by that is that large FDI flows into real estate tourism and construction. For example, usually have short time horizons. They are not strategic. And in case of a shock, can dry up very quick. So this type of FDI is large in many countries in the Western Balkans. For example, half of FDI in Montenegro goes into the tourism industry. But FDI into real estate accounts for about one-fifth in Albania, Bosnia and Herzegovina, North Macedonia, Kosovo and in Serbia it is at about one quarter. Real estate investments are also not productive once completed and large tourism projects often rely on primary imported goods and services and thus have very few backward linkages to the domestic economy. And this is a point I want to repeat and emphasize. And this is the point about the importance of FDI in creating backward linkages to the real economy. If FDI is to be durable, if FDI is to be sustainable. We see countries in the region that have high share of FDI in manufacturing or backbone services actually doing better. They're more embedded in domestic supply networks and they're more embedded in global value chains as we heard earlier today. They're in better positions overall to withstand shocks. So against this backdrop of high public and publicly guaranteed debt, low private investment rates, low and weak FDI structures, as well as not to forget the limited flexibility of the monetary policy in these countries that either have unilaterally adopted the euro as they account currency like Kosovo and Montenegro or have fixed back to the euro or currency boards against this backdrop, what we worry about is that eventual normalization of monetary policy in the developed world or a change in financing conditions. Eventually we'll expose structural weaknesses in the region and lead to a reduction or to a further reduction of potential GDP growth. Here high investment rates are really needed to rekindle the income convergence which we heard this morning and its importance of it, especially more private investment I want to emphasize given the limited fiscal space that many of these governments have. So what could be done in this situation? Well reform momentum is needed and this is the title of our latest regular economic report on the Western Balkans which I have promised to make available to our organizers. Reform momentum is needed and I want to emphasize two pillars of this reform momentum. Number one, it is strengthening of the fiscal positions of these countries and here to echo the message of Lawrence on the fiscal point it's really critical and second it is about structural policies. On the fiscal side improving the efficiency of public spending is paramount. In the Western Balkans for example public spending is still dominated by spending on public wages and poorly targeted social benefits which account for about half of the total spending in all of the countries and for about two thirds of spending in Bosnia and Herzegovina. Accelerating public administration and social sector reforms are also critical and better public investment management or how capital expenditures are managed and direct that is of really big importance for growth and for increasing growth potential. There is work and an agenda, big agenda on the revenue side as well and here I want to point a couple of areas where also the World Bank as well as other international financial organizations are working actively. These are the areas on generous tax expenditures as well as about tools available for strengthening tax administrations. Another important agenda is the progressivity of taxes especially progressivity of personal income tax. And the last and I'll be very brief happy to take questions later on this is the structural policy agenda and here it is again about boosting the potential growth in these countries starting from entry competition on equal terms and exit. So here bottom line is reinforcing the public institutions to ensure that no one benefits from special treatment in the domestic market would encourage entrepreneurs to enter the market, innovate, exit if they have to, expand the pool of younger and more productive firms and ultimately create jobs in the region. Thank you very much. Thank you very much Galina and now last but not least Nadine Eli for the IMF. Thank you. Okay, let me start by thanking the ECB for a very interesting day of a conference and for inviting me to speak on this issue. Let me start by saying that when we got these sort of topics that had been outlined for the session they made us think a lot and in fact you may actually find some papers coming out down the road because we thought that the answers were not there at least immediately looking at the data. And so what I'm going to present does not actually show any serious econometric work which I think Lorons and her team are probably more advanced on that. But a sort of a broad trend of how we see things and a bit of an event analysis and bit of a comparative analysis between countries that peg and have a hard currency fixed exchange rates versus the floaters. So let me touch on, I think a lot has been said, I don't want to repeat so I'll go quickly through my story in eight slides. What we did first is look at, okay, well ECB spillovers to the region. One thing we did was we said, okay, well let's look at the last round. We had the APP program in 2014 and what happened to exchange market pressures in these countries. And exchange market pressures as you know is reflected by an index which shows that it can show up in three ways, changes in reserves, changes in exchange rate and changes in the policy rate. And that's really what the three components would be. They can't be a fourth one. So the idea is to see how those in these five countries, six countries, behaved, Bulgaria, Croatia, Hungary, Poland and Romania. And as you can see, there is a very slight uptick in these pressures, in the exchange market pressures since the introduction of the unconventional monetary policy in the last round. And they seem to have trended down since the turmoil began in the emerging markets last year. Now the other thing we did was to look at, okay, well how did various macroeconomic and other economic indicators behave just after the introduction of the last round of unconventional monetary policy by the ECB? And here we have what the results we have, I mean these are not results, these are basically plots and you can see basically that there is hardly any difference between the exchange rate regime that you may have here, between the floats and the managed floats and on one side and the pegs and currency board and fixed exchange rate on the other. And the only place you see differences is that after the unconventional monetary policy was introduced by ECB, the peg countries showed a faster increase in nominal credit to the private sector and that the float and managed float had a slightly lower real exchange rate appreciation over the period following that action or during the period that this was going on. Yields, we looked at long-term government bond yields between float, managed float and the EuroEA peg and here also starting from 2015, the trend seems to be that the peg and the fixed exchange rate countries saw a reduction in yields over time. Now I think what Lorons presented is probably more formal and probably has more weight in the sense of the variance decomposition and all that and the Euro factor so both these results have to be, at least our results have to be taken with a pinch of salt here. Let me focus on the last year's turmoil and what that meant for the region. And this did not have a straight answer because it depends on which data you use and it depends on what denominator you use in the data. So what we did was we tried to do two things here. One is, as you can see, this is May 18 to May 19, so one year. And we show how the new member states of the EU behaved relative to Latin America and emerging Asia over the course of the turmoil. And then we put that against the taper tantrum that happened between June of 13 and June of 14. So the time chart at the x-axis does not belong to the taper tantrum but it's also one year duration so you can see in perspective that the last year's turmoil is much weaker, much milder than what happened during the taper tantrum. Financial conditions are also difficult to measure based on data. We use the EPFR data here and what we did was we plotted the financial condition index for Czech, Hungary and Poland against sort of these nine large emerging markets. And again, you can see sort of tightening of conditions as the sort of emerging market turmoil was unfolding and then after September of 18, things begin to ease off pretty much in line with the other EMs. I think one point that got made here a little bit but is worth mentioning is that in a macroeconomic vulnerability sense, the SESI countries are in a very different place than they were prior to the unfolding of the global financial crisis. And this may be the reason why the spillovers to the region are not so severe because the channels of those, the taps of those spillovers have been turned down or turned off. Let me start by the top left which shows the current account balance and the progression. You can see there's been a substantial reduction in the current account balances over these last so many years. To the extent that you can now say the region is except for a few countries, fairly the external imbalances have been brought under control. Fiscal buffers have been built up. Is the glass half full or half empty? Yes, they should have been built up even more. Fiscal policy has been sort of expansionary, not as not as not as con not as con-tactionary as it should have been given the whether these countries are in the cycle. But nevertheless, the debt buffers are much better than they were at the peak fallout from the crisis. The bottom left shows how deposits have become a lot more important source of bank funding. So the channel of external financing, external funding that was spilling over and could have provided a channel of spillovers from external side has also been reduced. And not surprisingly, nominal credit growth, which despite the strong sort of output beyond potential in many of these countries for a few years, we have a nominal credit growth that has not been growing, that has not been very high. And I think that again points to sort of the prudence of policies across the board. Let me finish by my last chart here, which comes out of our regional economic outlook. And you have to excuse me if it's not updated because I think they stopped this data back in September last year. But I think it shows an interesting trend. And what it was was for all of Europe showing how macro prudential measures have been increasingly introduced in these countries. And what I did was I put a green mark around the SESI countries. And it turns out a lot of the SESI countries have actually introduced a lot of these measures. And that in the end, we have a paper that will come out soon that will show that in fact, these measures, one thing they've done is they have restrained the very risky lending that took place, for example, prior to the crisis, whether they had an impact on credit growth or house prices is questionable. But the fact that again, the vulnerabilities channels that come through external flows have been dampened or have been shut down. So let me stop here and thank you very much, Nadim. Can we give a round of applause to all the speakers because I think they deserve it. And since they've been very disciplined and behaved, we have 45 minutes or so for a discussion, which is really good. Let me start with coming back to the older speakers and ask before I open the floor more broadly and ask if there is any comment you would like to share on what the others have said or anything that you forgot to say. And maybe just to kick off that discussion, I would like to come back to what I understood as a difference between what Laurence said and what Dubrako said, but I may be wrong, which is analytically quite important to understand the spillovers from the eurozone. Laurence said basically the euro does matter a lot because of euro invoicing in CZ countries.
 So let me give 30 seconds to for those of you who still stand to sit down if you wish.  You can also listen standing, it's okay.  So good afternoon, let me open the second session on our responses to monetary policy  and financial shocks.  We have a wonderful lineup to set the stage and start a discussion.  I would like to thank speakers for joining first and foremost and also to invite them  to be concise so that we can have time for a broader discussion with the audience.  I would also like to invite you to not to feel too much constraint in the presentations  and discussion.  That is the session being titled responses to monetary policy and financial shocks.  That could be a very narrow way to look at the discussion which would be to focus on  spillovers from ECB monetary policy and spillovers from US monetary policy and how CZ countries  have reacted to that.  And that certainly will be the core of the discussion but we also have an opportunity  to discuss macro-prudential frameworks, financial resilience which is very much part of what  both President Draghi and the IMF MD have discussed this morning.  So I would really encourage you to broaden the discussion to all aspects of resilience  in the macro and financial field.  And last but not least, it's good to be in a conference where it's not all about trade.  So we have a group, we have an opportunity to show that it's not all about trade.  And I'm sure it will be exciting.  So let me open the presentations with the first keynote speaker, Laurence Boone, Chief Economist  of the OECD.  Thank you.  Thank you Benoit for this very nice introduction.  I will unfortunately start by being a little narrow because in this presentation I will  focus mostly on spillovers from the ECB but I will not talk only about monetary policy  so hopefully it will open the door to the question that you want to raise afterwards.  Today I would like to discuss the macro framework in fact and the main message I would like  to leave you with is has to do with three points.  The first one is that also the exchange rate regime is generally floating for most easy  countries and they have strived to achieve stable inflation and stable financial condition  but while showing preferences for minimizing exchange rate fluctuation in a number of them.  And within this framework as long as the business cycle is in harmony with the emu aggregate  with the euro area then the framework appears to function quite well.  However, over the recent period especially because most easy countries have rebounded  and recovered from the crisis much better than the euro area and inflationary pressure  are building up which is a sharp contrast to the euro zone then this type of framework  may create tension between monetary policy, financial condition and economic stability.  And so that drives me to my third point which actually and we haven't talked to each other  but is related to what Benoit was saying that there are other policy tools to consider when  we're looking at the macro policy framework.  There's prudential and supervision on the one hand and there is fiscal as well on the  other hand.  And what I would insist on here is that the presentation will suggest that fiscal policy  may have been prosyclical and contributed to fuel the acceleration of the season in comparison  with euro area which would argue for a more balanced policy mix with tighter fiscal policy  to moderate the business cycle and that would allow central banks to actually have a more  gradual monetary policy tightening and therefore exchange rate appreciation.  And obviously that's assuming that trade tensions do not escalate but that was this morning  discussion.  So what I will do today is I will first recall rapidly what the theoretical channels for monetary  policy transmission and financial policy transmission are through trade, through finance and then  I will show you some empirical work which we have done at the OECD to assess the strengths  of these channels and then come back to the conclusion.  So there are two categories of channels which can shape spillover as you know from the euro  area to CZ countries.  Trade and finance.  We've discussed extensively trade this morning so what I will do here is simply focus on  how your area monetary policy can affect the CZ GDP and inflation through trade.  And there are two main channels.  As you know the first one is the income effect so if the euro area loses monetary policy then  it increases demand for non-euro areas, economies exports of goods and services.  This in turn tends to boost those economies output and it creates commovements with the  euro area output.  But then there might be a second effect which is an expenditure switching effect.  So under a flexible exchange rate regime when the euro area monetary policy becomes more  accommodative this is the exchange rate should appreciate unless monetary policy will respond  one for one.  And in turn the exchange rate appreciation should mitigate the increase in exports from  the income effect.  All together the combined effect will depend on the elasticity of substitution and the  degree of openness which we discussed extensively this morning and the extent to which the countries  are actually integrated into the euro area value chain.  But what I would like to focus on which is why we have this chart here is at least for  these three or CZ countries even so the euro area we have floating exchange rate regime  in practice.  And this is not only relevant for the Czech Republic, Hungary and Poland but in practice  most CZ countries have shown preference for limiting exchange rate fluctuation vis-à-vis  the euro.  And in addition what you can see from this chart is that most of the export of CZ countries  to non-euro countries like to your countries obviously given the importance of value chains  across Europe are actually invoiced in euro or actually it's more invoiced in euro for  export than when you compare to other countries and for import it's slightly different because  we have a commodity effect here.  So if we add all this together we're probably not really under a floating exchange rate  regime and we could anticipate that the income effect should dominate and the transmission  of euro area GDP fluctuation or monetary policy impact on GDP fluctuation should impact the  CZ countries in about the same way.  And before I move to the financial linkage perhaps just a snapshot on inflation where  here we expect that inflation fluctuation are not so much reflecting what's happening  in the euro area because of the importance of commodity and prices, energy and food,  energy which will tend to be invoiced in dollars and also because over the recent period there  has been some countries specific in geosyncratic shocks like a lot of indirect taxes, employer  social security contributions and statutory minimum wage movement in some of the CZ countries.  So that's for the trade effect.  Now let me move to the financial one.  So financial integration of economies can be reflected through three main channels.  One is portfolio holdings.  The second will be non-financial sector, boring and the third will be cross-border banking.  And what you see here is the stock of portfolio liabilities and what we wanted to show with  this chart is when you compare CZ countries with other neighboring countries of the euro  area which are in the EU for example, then you can see that the role of the euro is much  more important for CZ countries in terms of portfolio liabilities than for the others.  So in theory more accommodative ECB and I'm saying accommodative because it's to take  an example obviously not because I take a stance on this can affect financially CZ countries  through the three channels.  The first one will be the substitutability between EMU and CZ assets in portfolio.  So if we abstract from safe heaven effects then lower euro area interest rates should  put pressure on CZ interest rates as investors search for yield.  And indeed we have observed that in this presentation which will be on the web in the annex you  have a chart with short term and long term interest rates and you can see that whether  countries in Central and Eastern Europe were close to the zero lower bound or not, interest  rates movement from the euro have impacted interest rates in the CZ countries and when  they were close to the zero lower bound the spread has been compressed as well.  So overall when we have loser financial condition from this channel in the euro zone then it  translates into loser financial condition in CZ countries.  The second channel is the balance sheet channel which you know well and that relates to the  one of the point that Benoit Curre was leading to which is that to the extent CZ liabilities  are in euros while the assets may be in local currency then more accommodative euro monetary  policy should generate positive valuation effect.  In fact when we look at the evolution and what happened in CZ countries since the financial  crisis I think this channel is perhaps less prevalent than it used to because the stock  of euro denominated loans to the non-financial private sector has been falling significantly  in the wake of the crisis and in particular for households in some countries.  And again there's a chart in the annex that shows that quite clearly.  And then last but not least there is the third channel which is cross border bank lending.  Obviously if we have more accommodative lending condition in banks in euro area countries  or from euro area countries supplying loans to CZ countries then that should support credit  bank credit to CZ countries.  So together if we add all these channels with relatively stable exchange rates more accommodative  monetary condition in the euro area is expected to translate into more accommodative condition  in CZ countries both directly through the movement of emu and CZ interest rates but  also indirectly because it improves the domestic funding condition.  And I think when we add the trade channel and the financial channel then we can expect  really a strong impact from the euro area monetary policy.  So let me now turn to what we have found empirically and I will present the results of two way  of looking at this which are pretty much in line with what the literature in this area  has suggested.  And basically what our empirical analysis confirms the importance of these two transmission  channel.  So first we've used a very simple factor model analysis which breaks the contribution to  the variance of financial variables and also unreal variable into global, regional, regional  being European and country specific factors.  And what you can see here is that we are seeing a strong influence from the regional channel  so the European channel on the movement in the tenured government bond yield compared  with the other channel whether it's global or it's country specific.  And you have three CZ countries, Hungary, the Czech Republic and Poland on the right  hand side and the red block which is the European contribution is much larger than for any of  the other area that we look at whether it's non-EU or EU countries.  We've done that for equity prices as well and you find the same phenomenon where the  European component is much larger than the global or the country specific component.  It's quite interesting to see that in Norway and the UK for example the country specific  component is very, very significant.  And then we've also done this decomposition for inflation and like as I discussed earlier  the results are very in line with what we should expect meaning that this time the three  OECD CZ countries are much more sensitive to the global condition and that's the role  of commodity prices than they are to the European factor.  But even there what we can see is that the European element is still playing a significant  role but not bigger than for other EU neighboring countries.  And finally we do this decomposition for GDP growth and here as well what we can see is  a strong predominance of the European factor.  And I think this reflects quite well the discussion that we had this morning on trade which is  how open and integrated into the value chain the CZ countries are even if here we focus  only on three of them.  So that's a very simple nearly descriptive analysis.  It provides evidence of co-movements but it doesn't really look at the spillovers.  It's just showing the share of which factor.  So what we've done in another exercise is actually have a large scale Bayesian var  models to gauge the main transmission mechanism of the spillover and here I'm only showing  the Czech Republic but we have similar results for Hungary and Poland.  And it's once again confirming what we were when I was discussing in the first part of  this speech which is the importance of the European factor for the CZ countries.  What you can see clearly is if the eurozone lower interest rates by one standard deviation  then we have the same type of shock on the interest rate that's the left-hand side chart  then it vanishes as GDP which is on the right-hand side chart actually increases and equity  prices move a lot more as would be expected from this type of exercise.  I have not we have not represented here the exchange rate channel because it was insignificant  which is indeed what we would expect if the exchange rate was pretty much stable over  the period.  And again these results hold for Hungary and Poland as well.  So I think when we look at the short and limited empirical evidence that I present here this  is in line with what we know of the classic Monday flaming trial and mark.  So CZ countries have free capital flows with the euro area so if they wish to pursue stable  exchange rates then monetary policy is not really autonomous.  And this is fine when the two regions are moving in a synchronized way but it's much  more complex obviously when the business cycle diverges.  And when we look at the most recent period since the crisis the recovery has accelerated  faster in CZ countries than in the euro area and inflation has recovered closer to the  target so that the high degree of monetary transmission may have actually contributed  to two accommodative or more accommodative monetary policy in the CZ region that were  wanted by domestic condition.  And what I want to show you here it's over the period 2015-2018 some charts that I find  really really striking because they compare the last three years that's the red dots with  the period before which is 2007-2014 and you look at the movement in interest rate compared  with inflation and you can see that the blue dot which is the previous period seems much  more in a way tighter or if you look at the red dot you can see that it has taken much  more time and sometimes it hasn't even happened yet for our short term interest rate to go  up in spite of the inflationary condition.  There's a difference which is clearly visible for example between the Czech Republic and  Poland if you look at the Czech Republic monetary policy looks on this chart accommodative  for a while and over the most recent period then there has been a high interest rate so  we're converging towards the blue line and the former relationship that we had but when  we look at Poland we can see that we're way below what would have been the case for this  inflation in the previous period.  So I quite like this chart because I think they contrast very well how monetary policy  looks much more accommodative over the past three years than what it had been before for  similar inflation.  And I would like to conclude here it's actually I'm going to try and move into the annex if  I have the time for one minute.  Okay well I want to show you here is the fiscal stance because we have on the one hand monetary  policy which looks very very accommodative and on the other hand and that's just for  a short period but we could take it a little more what we can see here is we have a very  stimulating fiscal policy either in 2018 or 2019 for Poland in spite of the fact that  economic growth is very high and that inflation is picking up and I don't think I've put  them here but when you look at unit labour costs in these regions they have increased  very very fast and they have squeezed profit margin and we can expect them to actually translate  into inflation quite soon.  So let me go back on well actually since I'm here you can see the interest rate movement  I was mentioning earlier.  So to conclude and before I get stopped by the chair of the meeting let me leave you  with these three points first I think if if pursuing a stable exchange rate with the euro  so that there is strong monetary policy transmission from EMU then CC countries may have little  room for maneuver with monetary tools and this can be an issue when the business cycle  appears to synchronize and the imported monetary policies not really appropriate for domestic  condition.  So some would say that this could suggest that domestic central banks should react more  forcefully to the domestic condition and let the exchange rate appreciate.  But what I would like to argue and that's why I showed the last slide is there's no  reason to put all the burden of the adjustment on the shoulder of central banks.  What you could see in the previous slide is fiscal policy has been and is being prosyclical  in some countries which together with sizable EU structural fund flows because that provides  you to buffer may have contributed to fuel economic activity more than was necessary  given the strengths of the recovery.  So it's the overall policy mix which may have been too supportive given the brisk economic  momentum.  And I think to the extent that the policy mix may create domestic imbalances and I was  mentioning the sharp appreciation of unit labor costs for example then there may be  some scope to use fiscal policy in a more counter-synclical way that is to tighten fiscal  policy which would allow central banks to actually tighten their monetary policy more  gradually and with less exchange rate appreciation.  Obviously all these to the carriers that trade tension do not increase.  And the one last thing is I think the financial condition of all the countries was very different  which is why I didn't get into this.  But when we looked at it some countries have really also taken very significant macro prudential  measures and I'm thinking for example of the Czech Republic but in other countries this  transmission of monetary policy has also financial implication and their scope to discuss supervisory  and prudential policy as well.  Thank you.  Thank you very much, Lohan.  This sets the stage very nicely and also makes for a good transition with the discussion  this morning.  You've also shown how trade structures shape the sensitivity to external shocks also in  the macro and the financial field.  So I guess the punchline is that it is a vindication of the Moundel dilemma but there are also  elements of a dilemma in your presentation because you also show how much the for instance  long-term bond yields have been also impacted by ECB policies.  So there is a global financial cycle, a regional financial cycle also which interferes with  these decisions.  So I guess we'll have time to discuss it further and without due delay I give the floor to  Dubravko Mihalyek from the Bank Financial Settlements.  Thank you, Mr. Kure.  Good afternoon, everyone.  Thank you.  Thanks to the organizer for this opportunity.  I would like to extend a bit the discussion so far.  We've been talking about transmission of real shocks, then financial and monetary shocks  from EU to this region.  I would like to talk a bit about transmission of global financial conditions to the region.  So let me start with this chart which is showing global purchasing managers indices for manufacturing  and services in the left-hand panel.  The upshot is that the global economy is slowing.  You see the green line in the left-hand panel below 50.  So this means purchasing managers around the world are ordering less and the activity is  no longer expanding.  It's contracting.  And then on the right-hand panel you see further explanation of what's happening.  Global trade is no longer expanding.  There has been this steep drop late last year, early this year.  And then in particular, the blue line, the new export orders, you see no longer expanding.  They are contracting.  But interestingly, what's happening is that at the same time manufacturing is contracting.  Employment is still relatively strong and the capacity utilization has been for a while  holding up.  Left-hand panel, in the center panel you see that consumption is holding up well.  PMIs that describe consumer goods and services purchases are still in the positive expansion  territory.  However what's not so good for the outlook is that investment has weakened considerably.  When you look at the right-hand panel, these are subcomponents of PMIs for industrial goods,  for machinery and equipment, for electronic computing equipment.  All these at the global level are currently in the contraction territory.  So what is happening?  We know there are trade tensions.  We know there are political uncertainties.  And the region, Central Eastern, South Eastern Europe, has been affected through global value  chains, what we heard this morning, notably German manufacturing.  And reflecting these developments and below inflation outcomes, monetary policy is no  longer tightening.  In draft program for this conference was first circulated in December of last year.  Monetary policy normalization in the US was underway for three years.  And in the Euro area, ECB was taking initial steps towards normalization by ending net  bond purchases.  Now against this backdrop of global slowdown, monetary tightening is no longer imminent.  So where could this change in financial conditions come from?  Presumably it could come through a rise in risk premia.  With still weaker trade outlook and political uncertainties, business and investor sentiment  could be dentined and risk spreads could widen.  You can see, for instance, that they have already widened for corporate bonds and for  emerging market bonds.  A particular concern is further strengthening of the dollar.  There is a fairly large body of literature which documents an empirical relationship  between the strength of the dollar and global financing conditions.  If you look at graph seven left hand panel, you see that there is an interesting relationship  with when the dollar nominal effective exchange rate weakens, financing conditions ease globally,  and more credit is flowing to emerging market firms.  And vice versa, when the dollar strengthens, as has happened over the past year and earlier  this year, this means tighter financing conditions and less credit flowing to EMEs.  So we've heard a bit about the economics behind this relationship.  On the supply side, credit worthiness of borrowers improves as dollar denominated liabilities  fall relative to domestic assets.  This reduces tail risk in banks, credit portfolios, relaxes value at risk or economic capital  constraints, and creates capacity for additional lending.  On the demand side, balance sheets of firms that borrow in dollars strengthen when dollar  liabilities decline in domestic currency terms, and this may encourage more borrowing in dollars.  So these are some of the familiar relationships.  However, what is not widely known is that this, the broad dollar index, nominal effective  exchange rate of the dollar also tracks closely changes in global manufacturing activity measured  by PMIs.  As you can see in the right-hand panel here, there is again an interesting relationship  between PMIs for global manufacturing, which tend to weaken when the dollar strengthens.  And what's more interesting is that this relationship holds not just for advanced, for emerging  market economies, as you would expect, but also for advanced economies.  As this graph shows on the left-hand panel, we have PMIs for Germany, Italy, and Austria,  and the black solid line is the dollar nominal effective exchange rate.  You see fairly close inverse relationship.  Right-hand panel shows the same for Czech Republic and Poland.  So this is a bit surprising for Europe, because we take it for granted that the euro, not  the dollar, sets financing conditions for the real sector in Europe.  This association between the dollar and real activity is, of course, a correlation.  It's not a causation.  But it's unlikely to be coincidental.  It could reflect so-called working capital channel of trade fluctuations.  And this working capital channel features on one hand global value chains, and on the other  hand, prevalence of dollar in voicing in global trade.  And the upshot of interaction of these two themes is that stronger dollar, as we can  see indeed from these graphs, is associated with tighter credit conditions for financing  working capital.  We don't know how strong this working capital channel is in Central and Eastern Europe.  But we know what we heard earlier that Central Eastern Europe is highly integrated with euro,  area, real, and financial sectors.  So this enables us to use insights from models of monetary and financial spillovers via internationally  active banks.  What this literature tells us is that for domestic transmission of shocks, the key issue is understanding  heterogeneity in individual banks' responses to domestic monetary shocks.  And for international transmission, similarly, we also have to look at global banks' cross-country  responses to monetary shocks.  So what we've talked so far about is mainly a case of borrower and lender countries.  But what if the bulk of cross-border lending is denominated in a third global currency?  Multinational banking groups raise funding and extend credit in a range of currency.  On behalf of BIS, reporting banks, cross-border assets and liabilities are denominated in dollars,  and about a third are in euros.  So this means that monetary policy of a third country, neither the lenders nor the borrowers  may also come into play in cross-border lending spillovers.  Recent examples are what we are showing here, what we have just shown before, US dollar,  and hence FEDS monetary policy.  A case that is familiar to Central Eastern Europe is Swiss Franc and SMB monetary policy  few years ago.  So recent work at the BIS has shown that indeed all three monetary policy, lender countries,  borrower countries, and then currency of denomination country monetary policy can all play a role  in these cross-border spillovers.  And again, the strength of transmission of these channels depends on frictions that banks  face and borrowers face.  So it's more a question of micro level, bank level situation that determines how strong  is the transmission of spillovers.  One study that I think is of some interest to countries in this region is the one done  by Hayek and Horvat who examined specifically shocks from Euro area in the US and how they  affect economic activity and prices in non-EU countries, non-Euro EU countries, Bulgaria,  Croatia, Czech Republic, Denmark, Hungary, Poland, Romania, Sweden, and UK.  And to see in this graph are responses of industrial production to 100 basis point increase  in the ECB shadow policy rate by country over 12, 18, and 24 month periods from the model  estimated by Hayek and Horvat.  And you can see from these dots that on average industrial production growth falls by about  0.5 percentage points for 100 basis point increase in shadow policy rate.  The response to Fed's shadow policy rate increase is somewhat smaller, but it's also statistically  significant.  So what do we make from this?  What kind of policy responses to financial shocks can we think of in countries in central  and eastern Europe?  Overall I think there is now a body of evidence which shows that real activity in central  eastern Europe is quite sensitive to changes in global financial conditions.  So one implication straightforward is the need to monitor how these conditions evolve  and how they spill over to the domestic economy through bank and non-bank credit.  When you look back to last year and early this year, financing conditions in the region  have tightened slightly.  This is based on EIB landing survey for the region.  Funding conditions for international banking groups active in the region were easing last  year supported by the growth of deposits and collateral requirements were also easing.  However, longer term funding conditions have not eased.  And this resulted in a gap between demand for credit on the part of firms, especially  for working capital and supply of credit.  So if global financial conditions were to tighten further this year, firms access to  finance could become a constraint to growth.  What sort of responses could we then think of?  I think one channel of transmission that is important but is not often considered at  length is that of credit constrained firms, especially SMEs.  This morning Deborah mentioned this channel.  In small firms are also financially more opaque and their owners often have to use housing  equity as collateral for firm credit.  This implies that changes in domestic policy rates and macro-potential regulations can  have pronounced effects on SME activity in some countries.  Some work that my colleagues have done at the BIS with firm level data show that indeed  these collateral lending channel can be economically important.  For instance, in Spain and Italy, a one percentage point change in the growth of collateral values  induces a percentage point change in liabilities of SMEs and a similarly sized change in their  investment.  We are talking here about firms with less than half a million in total assets.  And furthermore, these changes in collateral values mostly affect employment in young firms,  less than five years old.  Other firms are able to grow employment from current revenues rather than bank borrowing.  So since in central and Eastern Europe access to bank credit is likely to be more constrained  than in Italy and Spain given the relative state of development of their banking systems  and legal frameworks, especially data aspects governing recourse, loan enforcement and bankruptcy  resolution, I think monetary policy potentially can have important effects through collateral  value and this balance sheet channel.  I will stop there.  Thank you.  Thank you very much, D'Wafco.  There was a fascinating difference of perspectives in the two presentations with Lawrence focusing  very much on our CZ countries as neighbors of the ECB and EMU and you, D'Wafco, focusing  on the global, taking the global perspective.  And of course both are important.  So it's really the two sides of the same discussion.  And I would really like if we could spend a little bit of time later on discussing the  banking channels which you've started to introduce in our discussion.  It's a key policy question for us as ECB and as Eurozone that we take into consideration  not only spillovers and spillbacks from EMU and into EMU as a monetary union but also  as a banking union.  And so the cynical view would be it doesn't matter so much because we are in incomplete  banking union anyway and our home host issues also inside EMU.  So maybe it doesn't matter so much whether you're inside EMU or outside EMU because  there are home host issues everywhere.  But if we can progress towards what is our objective to have a single banking area inside  EMU, then the issue will arise as to which kind of spillovers we create for countries  outside of EMU.  And this will be very important for the transmission of shocks.  So thank you for introducing that dimension.  Let me, so we now have four panelists and the first panelist is Mugur Irisarescu Garno  of the National Bank of Romania.  Mugur, thank you for joining.  Thank you, Mugur.  I like to make three short comments in my limited time.  One is about our topic.  One is a general one, general comment.  The other two will be related to the view from inflation target our position.  The first general one is what could we understand about the monetary policy normalization that  generally meaning is or broadly speaking is a policy normalization which implies two process.  The first one is the withdrawal of unconventional instruments.  You start at the outbreak of the global crisis.  It's clear this is a difficult and lengthy process which involves adjusting the balance  sheet of the central banks, particularly in the large central banks.  The influence on the global asset prices.  The second process is the increase in the short term interest rates.  This is equally intricate one, taking into account its effects on financial stability  and the current relatively high endemnness all across the world, particularly in some  countries in the European Union.  Then if you were supposed to ask me two months ago what is the policy normalization, I was  supposed to say that the question is not when, is not if this is going to happen, but when  it's going to happen.  Now, as you've already said and you said before me, and it's good that you said before me,  it's going not to be imminent, this kind of policy normalization, particularly related  to the increase in the policy rates.  Let me say that it is debatable if the forthcoming normalization process involves going back to  the pre-crisis normal or we are going to have a new normal which will be characterized by  lower interest rate and possible by larger central bank balance sheets which will be  for a pretty longer period of time.  If you ask me now, I'm biased to say that perhaps a new normal is going to happen, but  this is only a comment I have.  Regarding the other two comments, that will be from the position of the National Bank  of Romania which is an inflation targetter, that we are exactly like Poland, Czech Republic  and Hungary central banks, inflation targetter.  Since 2005, we define from the very beginning that we are considering and we consider light  inflation targeting.  For example, we never accepted to have a free floating because of sensitivity of exchange  rate movement in the Romanian economy.  We had the managed floating for example, but in the meantime it was changed.  What is happening is that we remain loyal to the inflation targeting, but the inflation  targeting is no longer loyal to us.  It was so many changes into the inflation targeting framework that particularly in the  last several years is something like a different framework.  I will say only two words about two underlying principles.  One is that after the outbreak of the global crisis and in the post-crisis development,  that it was a departure from the old orthodoxy particularly on the exchange rate policy.  For example, before the crisis, Forex interventions were more or less considered to be damped.  It's not good now.  It was Czech central bank which started with this.  It was going somewhere to a full commitment to, for a period it's true, since 2013 to  2017 to have exchange rate commitment and to intervene with our time or volume limits  to prevent the appreciation of the corona.  I quote what the Czech central bank said.  We're not in this position, but we did intervene in the Forex market to alleviate the large  fluctuations of the Forex and particularly to discourage Forex credit, which we discovered  that is undermining the monetary policy.  We are targeting, for example, monetary policy to curb inflation, but the aggregate demand  was rampant, was increasing via Forex credit, which was very dangerous.  In this respect, I found that also the general manager of BIS, Augustine Carstens, said that  this is a general trend in all the emerging markets, not only in the European central  and Eastern European countries with inflation targeting, to have a new definition of inflation  targeting, which is based more on the intervention of the Forex market.  The second is with the macro-pudential tools, which were now clearly a part of inflation  targeting.  I could say that inflation targeting is no longer so clean as it was 10 years ago, and  perhaps is for better because the central banks have now more, to say, not mandates,  more goals to achieve.  It's also related to financial stability.  We ask from time to time not to discourage economic growth.  We are under populist attack.  That's not only in the Eastern Europe, also in South Eastern Europe, I have seen in the  central Europe.  The second or the third comment is related to the policy rate, what is the central bank  in our area doing with the policy rate?  What is the situation?  The classic recipe for inflation targeting was to recommend a policy rate hike when the  inflation was moving up, and to have positive policy rate and generally positive money market  rates.  However, if you look to all the countries like inflation target, Czech Republic, Poland,  and Hungary, and also Romania, we have no negative interest rates, and our policy rate  is below the inflation.  We increased three times in Romania the policy rate last year, but to stop, why?  Because for example, in Romania, inflation is around 4%.  Policy rate is 2.5% in Hungary, is also around 4%, 3.9%, and inflation.  The policy rate is 0.9%.  We discovered that we are moving only in this direction.  There are the danger of having capital inflows to appreciate the currency, and we have a  problem of balance of payment.  We have a current account deficit.  And we have to be very careful to this movement.  We prefer, for example, to tighten money conditions through, let's say, liquidity control domestically,  and not to increase the policy rate and to have more flexibility.  But I couldn't say this is the good advice to the others.  It was the kind of innovation because I discovered, and we discovered there are a lot of innovations,  not only in Romania, all around the world.  And looking forward, and now I'm going to read because we don't have oral guidance,  and regarding the future, I like to be constructive ambiguity, what we are going to do.  Looking forward, the National Bank of Romania future policy actions will definitely depend  on the way monetary policy normalization unfolds in Europe.  What happened in the emerging economies, for example, that are part of the US dollar sphere  influence following the Fed's policy normalization is quite relevant.  Higher interest rates developed toward in the US would trigger a capital flight away  from emerging economies, thus generating depreciation pressures.  The response of policymakers in emerging economies will depend on the specific strengths and  weaknesses where adequate policy buffers are in place and investor confidence is elevated.  Market mechanism, counter cyclical, macroeconomic and prudential policy may be relied upon to  tackle a slowdown in capital inflows.  Where is the less room for maneuvering, tight and monetary and fiscal policy, policies may  be required to lower financing needs and attract additional inflows.  Where foreign reserves are adequate, they may be used to moderate or musn exchange rate  depreciation.  Which a versa if the situation in Europe will remain with a pretty low or quite negative  interest rates, for inflation target I guesstimate will be very difficult to increase policy rates  and money market rates.  Otherwise, there is the danger of exchange rate appreciation which first reaction is,  this is good for inflation going down, but if you have as is the remaining case, if you  have a problem with the current account deficit, this is only worsening the situation and only  postponement of the problems.  Then let me to say a conclusion.  It follows that when the normalization wave hits, the magnitude of the impact will depend  on how vulnerable emerging economies when our countries consider central and eastern  and south eastern Europe like emerging economies or of course, share republic is not, are to  external financing.  A contained current account deficit, a long average maturity on public and private foreign  currency debt and coherent mix of counter-cyclical macroeconomic policies and structural reforms  would go a long way in limiting the risks.  If proper economic policy actions are not implemented while there is a window of opportunity,  the possibility of a forced resort in a more or less distant future to the suboptimal and  improvised measures in the face of adversity cannot be ruled out.  To sum up, keeping domestic and external imbalances in check is long way our countries  will be able to cope with any strong volatility headwinds.  This is not difficult to be said in wording.  It's much more difficult to be put in practice, particularly when there are elections years  like we have now in Romania this year and next year.  Thank you very much.  Thank you very much, Mugu.  Well, since you were wondering, I think the working assumption that monetary policy tightening  in the eurozone is not immediate is a relevant assumption for our discussion.  So Dimitar, please, the floor is yours.  Thank you.  Thank you, Beno.  I will focus on the transmission of ECB monetary policy to the region as I was asked from the  country-specific perspective of Bulgaria.  My understanding is Galina and Nadine will look at it from the regional angle.  I will say a few words about the transmission of the ECB policy.  After that, I will shortly refer to the policy response to the changing monetary conditions  and finally I will say a few words about the macro-prudential measures that we introduced  to address the related financial stability risks.  Needless to say, the ECB's monetary policy plays an important role for economic activity  in the region due to, as was mentioned several times, to the high openness of the economy  and their strong trade and financial links with the euro area.  Recent empirical studies point to spillover effects from ECB's monetary policy to non-euro  area, EU economies, irrespective of the exchange rate regime.  Depending on the specific structural features of the economies, however, the strength of  the transmission can vary across countries.  For Bulgaria, the key features that determine the direct transmission of ECB's monetary  policy are related to the country's currency-ball arrangement with fixed exchange rate of the  national currency against the euro and the country's strong trade and financial integration  with the euro area.  Under the currency-ball arrangements, domestic monetary conditions are largely determined  by the monetary environment in the euro area.  The chart that you can see illustrates the parallel dynamics, respectively, of the left  and euro area overnight index averages.  An additional prerequisite for a strong pass-through of ECB's monetary policy to the domestic banking  system is the dominant role of the euro area on banks in the Bulgaria banking sector.  At the same time, around 50% of exports are distinct to the euro area, and the euro area  investors account for 67% of the stock of FDIs.  The effects of the direct transmission of ECB's policy measures since mid-2014 could  be illustrated with the high liquidity of the banking sector and the sustained decline  over the period in interbank money market interest rates and in interest rates on deposits  and loans against the background of strengthening macroeconomic conditions.  As for the channels of transmission, our research suggests that the effects of ECB's  monetary policy changes are transmitted to Bulgaria's economic activity mainly through  the foreign trade channel.  The effects from the change in interest rates and asset prices represented in this research  by residential property prices take more time to materialize and affect economic activity  to a lesser extent compared to the trade channel.  A few words on our policy responses to 2016.  Just to give you a flavor, I'll focus on one policy action with regard to the bank reserves,  and accounts with the BNB.  Given our monetary framework, the ECB's decision to introduce a negative interest rate in its  deposit facility in June 2014 led banks operating in Bulgaria to start holding excess reserves  in their accounts with the central bank since the interest rate and excess reserves at that  time were zero.  As a result, the 10-2015 bank deposits with the central bank in excess of the minimum  required reserves reached almost 130 percent on average daily basis.  To address these developments, we changed in 2016 our policy with respect to the required  reserves of banks.  We introduced a definition of excess reserves for bank accounts held with the BNB and introduced  the interest rate on the deposit facility of the ECB to be applied under excess reserves  when this interest rate is negative.  Zero interest rate is applied on excess reserves when the ECB deposit facility rate is positive  for zero.  The changes led to a strength, these changes in fact led to a strength and propagation  of ECB's interest rates to the Bulgarian economy.  Bank success reserves however remain sizable.  That is why as from October 2017 the central bank introduced an extra minus 20 basis points  at top of the ECB deposit facility interest rate with which bank success reserves held  that the BNB are charged.  As a result, there has been downward trend in excess reserves from about 56 percent in  October 2017 to about 26 percent of minimum required reserves on average daily basis in  April 2019.  Should illustrate this with the next chart which gives an idea about the changes in our  bank reserves and excess reserves along with the ECB deposit facility rate.  Finally, a few words about the financial stability implications that in my view are  very, very important.  The prolonged period of accommodative monetary policy of the ECB has helped the recovery  of economic activity throughout the EU but it has also increased the potential of buildup  of financial stability risks.  In the Sezy countries and in Bulgaria more specifically the favorable financing conditions  improving macroeconomic environment and high liquidity in the banking system have stimulated  credit activity while at the same time residential property prices have been increasing at relatively  high rates.  To limit potential risks we did mainly two things.  First, we strengthened our macro prudential framework and second, we activated the counter  cyclical capital buffer.  The key element of strengthening macro prudential powers of the central bank was the establishment  in 2018 of the legislative basis for borrower based measures requirements such as LTVLTI  in addition to the existing capital based measures.  As for the activation of the counter cyclical capital buffer we took two decisions so far.  First in 2018 we set the counter cyclical capital buffer rate applicable to credit risk exposures  in Bulgaria at 0.5% in effect from October 1st, 2019 and second early this year we further  increased the rate to 1% in effect from April 1st, 2020.  It's probably important to say that the rate is applied to the overall credit stock of  banks and not to the volume of newly issued loans.  It was also announced that the central bank could increase the rate to a higher level  earlier in the event of a significant acceleration of credit growth.  These decisions were taken despite the fact that the standard metric for deviation of  the credit to GDP ratio from its long-term trend remained deeply in negative territory.  This estimation however is sensitive to the time series sample and cannot provide timely  indication about turning points.  Therefore the decision for the increase of the counter cyclical capital buffer rate were  taken considering the relatively high growth rate of credit as well as on the basis of  an in-depth analysis of the financial cycle.  The chart, the last chart that I have in fact displays our aggregate measure of the financial  cycle.  It can be seen that in 2017 the economy was entering the initial phase of cyclical risk  accumulation.  To wrap up, I would like to emphasize the following points.  First, the monetary policy of the ECB plays an important role for economic activity in  the region because of the high openness of the economies and their strong trade and financial  links with the Euro area.  For in Bulgaria the currency bought on edgements lead to a direct transmission of the ECB's  monetary policy to the economy.  Second, the substantial monetary policy stimulus provided by the ECB through its non-standard  monetary policy measures has contributed to strengthening the monetary policy transmission  to the region.  The BNB has introduced changes to its policy with respect to the required reserves of banks  which have led to faster and stronger propagation of the ECB interest rates to the Bulgarian  economy.  And finally, the prolonged period of accumulative monetary policy of the ECB and the spillover  effects to the region create potential financial stability risks that need to be addressed with  adequate macro-prudential measures, including by strengthening the macro-prudential powers  of relevant authorities, the central bank in our case, and activating the counter-cyclical  capital buffers.  And I'll stop here.  Thank you.  Thank you very much, Dimita.  Of course this becomes even more important now than the Bulgarian has a clear perspective  to join both the exchange rate mechanism and the banking union.  So that's your unique in that perspective compared to the neighboring countries.  So we're now going to conclude by with broadening of the discussion with the views of the World  Bank and the IMF.  So let me give the floor to Gellina Vincelet for the World Bank.  Thank you very much, Chair, and thank you for inviting me to speak here at this conference  today.  I will indeed a little bit broaden the discussion, but at the same time focus it on the six  Western Balkan countries.  And I'll change a little bit my remarks as previous speakers did very eloquently explain  the transmission channels through which eventual normalization or a financial condition change  could affect the countries of the Western Balkans.  Instead I would like us to think about what are the conditions in these six countries  should an eventual shock arrive.  So I'll focus on the public sector, the private sector, and then think about what policymakers  can do today.  Starting with the public sector, last few years we have seen a significant improvement  in fiscal positions of the six Western Balkan countries.  This being said, public debt remains still at relatively high levels.  Countries like Montenegro and Albania have public and publicly guaranteed debt which stands  at 70 or above percent of GDP.  North Macedonia and Serbia are hovering around the 50 percent mark as well.  Moreover, and importantly, public debt is with a significant external component which  means that for example in Montenegro or in Serbia significant part of the debt is external.  And this is quite important.  Several of the Western Balkan countries also are running elevated external and domestic  imbalances.  So this taken together would imply that a higher interest rate spending could crowd out productive  spending in infrastructure as well as social spending.  It could also pose challenges for rollover of external debt and may become more costly.  And the dependence on these countries on foreign financing.  For the private sector, and given the global investment decline as Dubrovko showed us very  nicely in the chart, that would mean that there is a real threat of reducing private  investment rates in the countries.  At the end of 2018, private investment for the region stood at about 18 percent.  And this is not high.  This is for these countries to really ignite growth and to reignite convergence, investment  rates will need to be significantly higher.  Capital needs to deepen more.  Moreover, private investment in some of the countries continues to grow at rates slower  than the rates of growth of the economy.  This means that investment is shrinking as a share of economic activity.  I'll give you the example of Serbia here, where in 2018 last year, growth of private  investment was 2.5 percent compared to economic growth of 4.2 percent.  If we take a little bit of a longer perspective of the last decade, we see that private investment  has practically stagnated in this country.  Looking at foreign direct investment, again, FDI in the region remains low.  It is at about 5.5 percent of GDP today.  Again, you know, has come down significantly after the global financial crisis.  But what is important about FDI, it's weak structure.  What I mean by that is that large FDI flows into real estate tourism and construction.  For example, usually have short time horizons.  They are not strategic.  And in case of a shock, can dry up very quick.  So this type of FDI is large in many countries in the Western Balkans.  For example, half of FDI in Montenegro goes into the tourism industry.  But FDI into real estate accounts for about one-fifth in Albania, Bosnia and Herzegovina,  North Macedonia, Kosovo and in Serbia it is at about one quarter.  Real estate investments are also not productive once completed and large tourism projects  often rely on primary imported goods and services and thus have very few backward linkages  to the domestic economy.  And this is a point I want to repeat and emphasize.  And this is the point about the importance of FDI in creating backward linkages to the  real economy.  If FDI is to be durable, if FDI is to be sustainable.  We see countries in the region that have high share of FDI in manufacturing or backbone  services actually doing better.  They're more embedded in domestic supply networks and they're more embedded in global  value chains as we heard earlier today.  They're in better positions overall to withstand shocks.  So against this backdrop of high public and publicly guaranteed debt, low private investment  rates, low and weak FDI structures, as well as not to forget the limited flexibility of  the monetary policy in these countries that either have unilaterally adopted the euro  as they account currency like Kosovo and Montenegro or have fixed back to the euro or currency  boards against this backdrop, what we worry about is that eventual normalization of monetary  policy in the developed world or a change in financing conditions.  Eventually we'll expose structural weaknesses in the region and lead to a reduction or to  a further reduction of potential GDP growth.  Here high investment rates are really needed to rekindle the income convergence which we  heard this morning and its importance of it, especially more private investment I want  to emphasize given the limited fiscal space that many of these governments have.  So what could be done in this situation?  Well reform momentum is needed and this is the title of our latest regular economic report  on the Western Balkans which I have promised to make available to our organizers.  Reform momentum is needed and I want to emphasize two pillars of this reform momentum.  Number one, it is strengthening of the fiscal positions of these countries and here to echo  the message of Lawrence on the fiscal point it's really critical and second it is about  structural policies.  On the fiscal side improving the efficiency of public spending is paramount.  In the Western Balkans for example public spending is still dominated by spending on  public wages and poorly targeted social benefits which account for about half of the total  spending in all of the countries and for about two thirds of spending in Bosnia and Herzegovina.  Accelerating public administration and social sector reforms are also critical and better  public investment management or how capital expenditures are managed and direct that is  of really big importance for growth and for increasing growth potential.  There is work and an agenda, big agenda on the revenue side as well and here I want to  point a couple of areas where also the World Bank as well as other international financial  organizations are working actively.  These are the areas on generous tax expenditures as well as about tools available for strengthening  tax administrations.  Another important agenda is the progressivity of taxes especially progressivity of personal  income tax.  And the last and I'll be very brief happy to take questions later on this is the structural  policy agenda and here it is again about boosting the potential growth in these countries starting  from entry competition on equal terms and exit.  So here bottom line is reinforcing the public institutions to ensure that no one benefits  from special treatment in the domestic market would encourage entrepreneurs to enter the  market, innovate, exit if they have to, expand the pool of younger and more productive firms  and ultimately create jobs in the region.  Thank you very much.  Thank you very much Galina and now last but not least Nadine Eli for the IMF.  Thank you.  Okay, let me start by thanking the ECB for a very interesting day of a conference and  for inviting me to speak on this issue.  Let me start by saying that when we got these sort of topics that had been outlined for  the session they made us think a lot and in fact you may actually find some papers coming  out down the road because we thought that the answers were not there at least immediately  looking at the data.  And so what I'm going to present does not actually show any serious econometric work  which I think Lorons and her team are probably more advanced on that.  But a sort of a broad trend of how we see things and a bit of an event analysis and  bit of a comparative analysis between countries that peg and have a hard currency fixed exchange  rates versus the floaters.  So let me touch on, I think a lot has been said, I don't want to repeat so I'll go quickly  through my story in eight slides.  What we did first is look at, okay, well ECB spillovers to the region.  One thing we did was we said, okay, well let's look at the last round.  We had the APP program in 2014 and what happened to exchange market pressures in these countries.  And exchange market pressures as you know is reflected by an index which shows that  it can show up in three ways, changes in reserves, changes in exchange rate and changes in the  policy rate.  And that's really what the three components would be.  They can't be a fourth one.  So the idea is to see how those in these five countries, six countries, behaved, Bulgaria,  Croatia, Hungary, Poland and Romania.  And as you can see, there is a very slight uptick in these pressures, in the exchange  market pressures since the introduction of the unconventional monetary policy in the  last round.  And they seem to have trended down since the turmoil began in the emerging markets last  year.  Now the other thing we did was to look at, okay, well how did various macroeconomic and  other economic indicators behave just after the introduction of the last round of unconventional  monetary policy by the ECB?  And here we have what the results we have, I mean these are not results, these are basically  plots and you can see basically that there is hardly any difference between the exchange  rate regime that you may have here, between the floats and the managed floats and on one  side and the pegs and currency board and fixed exchange rate on the other.  And the only place you see differences is that after the unconventional monetary policy  was introduced by ECB, the peg countries showed a faster increase in nominal credit to the  private sector and that the float and managed float had a slightly lower real exchange rate  appreciation over the period following that action or during the period that this was  going on.  Yields, we looked at long-term government bond yields between float, managed float and  the EuroEA peg and here also starting from 2015, the trend seems to be that the peg and  the fixed exchange rate countries saw a reduction in yields over time.  Now I think what Lorons presented is probably more formal and probably has more weight in  the sense of the variance decomposition and all that and the Euro factor so both these  results have to be, at least our results have to be taken with a pinch of salt here.  Let me focus on the last year's turmoil and what that meant for the region.  And this did not have a straight answer because it depends on which data you use and it depends  on what denominator you use in the data.  So what we did was we tried to do two things here.  One is, as you can see, this is May 18 to May 19, so one year.  And we show how the new member states of the EU behaved relative to Latin America and emerging  Asia over the course of the turmoil.  And then we put that against the taper tantrum that happened between June of 13 and June  of 14.  So the time chart at the x-axis does not belong to the taper tantrum but it's also one year  duration so you can see in perspective that the last year's turmoil is much weaker, much  milder than what happened during the taper tantrum.  Financial conditions are also difficult to measure based on data.  We use the EPFR data here and what we did was we plotted the financial condition index  for Czech, Hungary and Poland against sort of these nine large emerging markets.  And again, you can see sort of tightening of conditions as the sort of emerging market  turmoil was unfolding and then after September of 18, things begin to ease off pretty much  in line with the other EMs.  I think one point that got made here a little bit but is worth mentioning is that in a macroeconomic  vulnerability sense, the SESI countries are in a very different place than they were prior  to the unfolding of the global financial crisis.  And this may be the reason why the spillovers to the region are not so severe because the  channels of those, the taps of those spillovers have been turned down or turned off.  Let me start by the top left which shows the current account balance and the progression.  You can see there's been a substantial reduction in the current account balances over these  last so many years.  To the extent that you can now say the region is except for a few countries, fairly the  external imbalances have been brought under control.  Fiscal buffers have been built up.  Is the glass half full or half empty?  Yes, they should have been built up even more.  Fiscal policy has been sort of expansionary, not as not as not as con not as con-tactionary  as it should have been given the whether these countries are in the cycle.  But nevertheless, the debt buffers are much better than they were at the peak fallout  from the crisis.  The bottom left shows how deposits have become a lot more important source of bank funding.  So the channel of external financing, external funding that was spilling over and could have  provided a channel of spillovers from external side has also been reduced.  And not surprisingly, nominal credit growth, which despite the strong sort of output beyond  potential in many of these countries for a few years, we have a nominal credit growth  that has not been growing, that has not been very high.  And I think that again points to sort of the prudence of policies across the board.  Let me finish by my last chart here, which comes out of our regional economic outlook.  And you have to excuse me if it's not updated because I think they stopped this data back  in September last year.  But I think it shows an interesting trend.  And what it was was for all of Europe showing how macro prudential measures have been increasingly  introduced in these countries.  And what I did was I put a green mark around the SESI countries.  And it turns out a lot of the SESI countries have actually introduced a lot of these measures.  And that in the end, we have a paper that will come out soon that will show that in  fact, these measures, one thing they've done is they have restrained the very risky lending  that took place, for example, prior to the crisis, whether they had an impact on credit  growth or house prices is questionable.  But the fact that again, the vulnerabilities channels that come through external flows  have been dampened or have been shut down.  So let me stop here and thank you very much, Nadim.  Can we give a round of applause to all the speakers because I think they deserve it.  And since they've been very disciplined and behaved, we have 45 minutes or so for a discussion,  which is really good.  Let me start with coming back to the older speakers and ask before I open the floor more  broadly and ask if there is any comment you would like to share on what the others have  said or anything that you forgot to say.  And maybe just to kick off that discussion, I would like to come back to what I understood  as a difference between what Laurence said and what Dubrako said, but I may be wrong,  which is analytically quite important to understand the spillovers from the eurozone.  Laurence said basically the euro does matter a lot because of euro invoicing in CZ countries.
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