20 January 2023

Michal Kokoř's Commentary: Inflation stories

2022 is a year marked by inflation. After a relatively long period when inflation dominated the most boring academic discussions, the rise in the price level became a central social issue this year. However, in a single year, we went from some of my acquaintances with non-economics degrees looking at me blankly when I mentioned the word inflation, to a situation where even the typical shoeshine boy down the street is adding an inflation clause to his price list.

Michal Kokoř

It is therefore logical that we cannot always work correctly with inflation, and at the same time, we have a general tendency to look at things in nominal rather than real quantities. Who would want to do a mental exercise in which they recalculate their salary to the actual number of things they can buy with it when it is easier to remember that just a few years ago a pint of Pilsner could be bought in a pub for xxx CZK (insert number from your student years). Inflation thus brings about some interesting effects that are not entirely obvious at first glance. Let's take a look at some of them.

The Czech Republic is catching up with the Eurozone at a dizzying pace

Inflation is significantly higher in the Czech Republic than in the Eurozone (Specifically, according to Eurostat data, the year-on-year inflation rate was 17.2% in the Czech Republic and 10.1% in the Eurozone in November). This in combination with the policy of the CNB, which, after the new governor took office, instead of raising interest rates, decided to dampen record inflation by artificially strengthening the koruna (From an average of 25.65 in 2021 to an average of 24.59 in the first 11 months of this year - i.e. strengthening by more than 4%), resulted in long-unseen growth of the Czech GDP (in EUR) compared to the Eurozone. By the way, it is worth remembering that the central bank uses foreign exchange reserves created in the days when it was still fighting against a hypothetical deflation of 0.1% in the years 2013-2017 by printing more than 2 trillion crowns and exchanging them for euros to strengthen the koruna.

GDP per capita in EUR - Comparison of the Czech Republic with the Eurozone published

HDP na hlavu

The inflation-inflated economy together with the doped koruna thus brought about the fastest economic convergence towards the Eurozone since the pre-crisis years of 2007/2008. The question remains whether the Czech economy can withstand it. If you are tired of watching economic data, a good indicator for watching this phenomenon can be, for example, the filling of parking lots at German supermarkets with Czech cars.

Government debt is falling

Well, not that the government deserves it in any way. The nominal indebtedness of government institutions has of course been growing at a high rate for several years, but economists look at government debt through the lens of its ratio to GDP. However, the GDP of the Czech Republic is also growing significantly due to inflation. For example, according to IMF estimates (due to the short-term nature of the prediction and the fact that we are already at the end of the forecasted horizon, these estimates can at least be broadly trusted) this year GDP will nominally grow by almost 13%, while the government debt will rise "only" by about 11%. In the final sum so at the end of the year, our relative indebtedness will be lower than it was at the beginning of it. In other words, the politicians are not keeping up with borrowing us at the rate that inflation eats away at your savings, and this situation will probably last at least into the next year.

Real estate prices are falling at the fastest rate in the history of the Czech Republic

The nominal prices of apartments in the Czech Republic have more than doubled over the past 10 years, but this year the real estate market seems to have run out of steam. According to a quick look at real estate server data, the trend reversed about halfway through the year and property listing prices have since started to decline, reaching around last November's levels (a view of actual realized property prices is of course better, but this development can only be tracked with a longer time gap).

The nominal year-on-year price stagnation thus led to a real year-on-year reduction in real estate prices by the amount of inflation - here we can choose from several relevant figures: a) 16.2% according to CZSO data; b) 17.2% according to Eurostat data; c) 19.8% according to CZSO data adjusted for government intervention in energy prices. The last time real estate prices in the Czech Republic fell nominally and in real terms from the last quarter of 2008 to the last quarter of 2011, while during these 3 years, their prices fell by 16.3% with a cumulative inflation of 5.7% - in real terms by roughly 22% (the fastest year-on-year real drop was recorded in 2009 by less than 10%). This year's fall in real property prices is therefore much sharper than the one after the financial crisis of 2008/2009.

In the end, however, it should be added that this discount is only relevant for you if your wages also rise with inflation, but this is not yet happening at the aggregate level, and real wages are falling to the levels of 2017 - the most among OECD countries. However, we will see how long the Czech employees like it and this situation will change.

Note (1): The CNB anticipates a similar development in its forecast. Conversely, the Ministry of Finance expects the debt-to-GDP ratio to rise slightly at the end of the year. However, the main conclusion does not change – the relative indebtedness of the Czech Republic is not as enormous as it seems at first glance due to inflation.