An Exchange Rate Floor as an Instrument of Monetary Policy: An Ex-post Assessment of the Czech Experience

In November 2013 the Czech National Bank introduced a floor for the Czech koruna exchange rate as its monetary policy instrument. The rationale for this action was to prevent the risk of deflation in a zero-lower-bound environment where policy rates could not be lowered any further. The goal of this paper is to assess ex post the effect of the exchange rate floor on the Czech economy - inflation and the main real aggregates. The paper uses two different approaches. First, the official DSGE forecasting model is used to simulate the counterfactual macroeconomic dynamics of no introduction of a floor. Second, the paper applies an empirical approach: the synthetic control method and its generalised variant are used to estimate these counterfactual trajectories. Both approaches show that the floor prevented inflation from turning negative. Moreover, both methods indicate likely positive effects on macro variables and on various measures of inflation, although strongly statistically significant effects are only obtained for core inflation. The statistical significance for other variables is weaker or zero. We conclude that the introduction of the exchange rate floor was a correct policy action that has retrospectively been successful.