The role of foreign currency lending in the impact of the exchange rate on the real economy

The purpose of our article is to define how the FX debt of the private sector changes the impact of the exchange rate on the real economy: to identify the balance sheet channels through which depreciation of the exchange rate has a negative impact on GDP and the factors which determine whether the overall impact of depreciation will be contractionary or expansionary. In our analysis, we identified three balance sheet channels. Depreciation of the nominal exchange rate increases the debt burden of companies and households which are indebted in foreign currency and have no FX income, leading in turn to lower investments and consumption. Although the direct FX exposure of the banking sector is not significant, if banks face binding capital and/or liquidity constraints, changes in the exchange rate may have an indirect impact on the credit supply of banks through a number of channels. Looking at the impact of a weaker exchange rate on growth, our calculations show that the effect of depreciation on the lending ability of the banking system is of key importance. If we only take into account the impact of the exchange rate on the balance sheets of the households and corporate sector, the impact on competitiveness is presumably stronger, but the impact of depreciation on household income and the profitability of companies with FX debts and no natural hedge will use up approximately 50% of the expansionary effect of increased competitiveness. However, if there is also a strong balance sheet adjustment in the banking sector, the overall impact of depreciation may well be contractionary. The effect of the exchange rate on the banks’ credit supply should, at least in such a strong form, be considered as a temporary phenomenon associated with the crisis. In parallel with the consolidation of the global financial environment and further improvement in the capital position and profit prospects of the banking sector, the credit supply channel is also expected to attenuate.bank lending channel, balance sheet channel, depreciation

Optimal Rate of Inflation in Hungary

This paper, requested by the Monetary Council, attempts to determine the level of inflation consistent with price stability, taking into account the characteristics of the Hungarian economy. Price stability is defined as the level of inflation that allows the maximisation of social welfare on a 15-20 year horizon, which corresponds to the first phase of real convergence. In other words, this study aims to determine the inflation rate that can be considered optimal within the given time horizon. In developed countries, the primary objective of central banks is the maintenance of price stability, in view of the welfare costs of inflation. Price stability is usually taken to mean a low, but non-zero, inflation rate. A positive inflation rate can be justified since very low inflation rates, in the proximity of zero, have been found to reduce long-term welfare. The negative welfare effect of zero inflation can be explained in terms of the following: asymmetric nominal rigidities, the risk of deflation, the necessity of positive nominal interest rates, and the statistical measurement bias in the CPI. These factors were examined in light of the catching-up status of Hungary, focusing, in particular, on the question of whether or not, due to its catching-up status, the optimum rate of inflation in Hungary is higher than the 1-2,5% inflation rate defined in developed countries. The findings of the study suggest that the inflation rate corresponding to price stability in Hungary is higher than the inflation target of the European Central Bank. Our calculations suggest that, in the long run, inflation in the range of 2,3-3,2% can safeguard against the costs of deflation. This level can compensate for the distortions in the CPI and allow for real price adjustments, even if Hungarian tradable prices move together with those of its trading partners and assuming downward price rigidity.optimal inflation rate, price stability, costs of inflation.

Tax evasion and tax changes in Hungary

Tax evasion reduces the efficiency of the economy as unequal opportunities of tax evasion leads to an inefficient distribution of resources. In Hungary, based on data for 2005–2006, tax evasion resulted in a transfer of 7.9 per cent of GDP from taxpayers to tax evaders. Following measures aimed to reduce tax evasion, this transfer was estimated to be 6.7 per cent of GDP in 2006 and 2007. Underlying reasons for tax evasion are the different burdens on labour and capital incomes. According to international experience, either the control of splitting labour and capital incomes or bringing their contribution burdens closer to one another can help in this situation. The effect of administrative measures is often temporary, because they do not improve tax-compliance attitude. A positive change in taxpayers’ attitude is an especially difficult task; one of its possible means can be a shift in the tax burden in favour of local taxes.taxation, tax evasion, hidden economy.

Is there a bank lending channel in Hungary? Evidence from bank panel data

In this paper we analyze the bank lending channel in Hungary. We provide a brief overview of the theory and the empirical approaches used to investigate the existence of bank lending channel. From the possible methods we use the generally applied approach suggested by Kahsyap and Stein (1995) which relies on discovering asymmetries in changes in the amount of loans to monetary actions in order to isolate supply and demand effects. We estimate an ARDL model where the asymmetric effects are captured by interaction-terms. We find significant asymmetric adjustment of loan quantities along certain bank characteristics. The existence of bank lending channel, and therefore loan supply decisions of banks, can explain these asymmetries. In addition, we do not find any sign for asymmetric loan demand adjustment along these variables. According to these findings, we cannot rule out the existence of the bank lending channel in Hungary.monetary transmission, credit channel, bank lending channel, ARDL model.

Structural challenges towards the euro: fiscal policy

Broad theoretical consensus and vast empirical evidence reinforce the view that prudent fiscal policy – also advocated by the fiscal institutions of the eurozone – can support the stable long term growth. After presenting some general principles of the optimal fiscal policy, the paper analyses the questions of fiscal convergence necessary for the successful eurozone entry and membership of Hungary. The paper calculates the consolidation necessary to reach the 2008 deficit target set by the Convergence Program. Taking into account of not only the level of the government debt but also the relatively progressed state of the interest rate convergence, the potential reduction attainable in the interest balance is moderate. The main result of the paper is that the necessary consolidation measures are required to reduce the primary balance by approximately 3 percent. In case of cutting public expenditure it would require approximately 4 percent reduction taking into account the revenue content of those expenditures. The structure of macroeconomic growth is not expected to facilitate fiscal consolidation – as wage and consumption growth, which have major influence on the development of relevant tax-bases, are expected to be moderate – and no improvements in the balance are expected as a result of the EU accession. International experience, especially fiscal consolidations of eurozone member states, however, show that structural – i.e. quality-improving and sustainable – measures and the reform of the institutional framework are essential determinants of successful consolidations. Temporary measures and deficit reductions by creative accounting do not foster macroeconomic stabilization and their eventual reversal is highly probable.Fiscal Consolidation, Optimal Debt Policy, Maastricht Criteria.