## 1. Inflation in Hungary and Europe

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---

### A. Overview and recent developments
- Inflation trajectory:
  - Accelerated from "2.7 percent y/y in January 2021 to 24.5 percent in December 2022."
- Common shocks and Hungary’s outturn:
  - COVID-related supply disruptions, surge in commodity prices, and Russia’s war in Ukraine lifted inflation across Europe; Hungary’s inflation rose to notably higher levels than all other European countries.
- Policy and macro drivers since 2020:
  - Extraordinary fiscal and monetary loosening in 2020 to respond to COVID-19.
  - Additional fiscal stimulus ahead of the April 2022 elections.
  - Widening external deficit led by high energy prices and sustained demand.
  - Tighter global financial conditions and disputes with the EU that intensified exchange rate and imported inflation pressures.
- Policy mix change:
  - By mid-2022 the fiscal-monetary policy mix began to tighten as fiscal policy reversed course and aligned with monetary policy.

### B. Composition of inflation
- Food inflation:
  - "Food inflation in Hungary is the highest in the EU."
  - 2022 drought curtailed agricultural production, adding pressure on unprocessed food prices; strong passthrough from unprocessed to processed foods and low productivity in food processing contributed to exceptionally high processed food inflation.
  - Government price caps introduced February 2022 on specific foods at October 15, 2021 levels; caps extended/expanded (eggs and potatoes) and set to expire in April 2023. Caps were ineffective in slowing food inflation as distributors and retailers raised prices on other products.
- Energy and fuels:
  - Household energy utility price caps in place since 2014 initially shielded households from wholesale price increases; an August 2022 adjustment increased the cap for consumption above the national average, exposing around one quarter of households to higher energy utility prices.
  - After the August 2022 change, electricity and gas consumer price inflation jumped "from zero to nearly around 30 and 115 percent y/y, respectively, in September 2022," jointly contributing close to "3 percentage points to headline CPI y/y" that month and remaining around similar levels through December 2022.
  - Motor fuels price cap (November 15, 2021 to December 6, 2022) was lifted in December 2022; fuel prices jumped by "27 percent y/y" and contributed close to "2 percentage points to headline CPI y/y" that month.
- Producer prices:
  - Domestic producer price inflation reached "nearly 68 percent y/y in October 2022" and declined slightly to "63.7 percent in November 2022," led by energy and intermediate good prices.
  - A historically high correlation between producer and consumer prices suggests much of the passthrough of higher production costs has already occurred.
- Core inflation:
  - Core inflation measures (excluding unprocessed food or both unprocessed and processed foods) are highest in the EU.
  - Services and nonenergy, nonfood goods inflation contributed around "40 percent of headline CPI inflation through December 2022."
  - Services inflation accelerated into double-digit territory and nonenergy, nonfood goods inflation rose faster than peer Emerging Europe countries.

### C. Inflation drivers — models, labor market, and policy
- Phillips Curve findings (panel: 21 advanced and 5 emerging European economies, "2000Q1–2022Q2"):
  - Past core inflation and three-year ahead inflation expectations are important drivers of current core and headline inflation in Hungary.
  - External price pressures (commodity food and energy prices, foreign producer prices, exchange rates) are statistically significant drivers.
  - The unemployment gap coefficient (based on historical trends) is statistically insignificant for Hungary over the full sample, similar to Bulgaria, Croatia, and Poland, though the relationship may have changed in the last two years.
- Labor market and wages:
  - Since "2020:Q2," core inflation has become more correlated with the unemployment rate than pre-COVID.
  - Labor market tightness (ratio of job vacancies to the unemployment rate) rose to historically high levels, indicating historically low labor market slack.
  - Private sector wages grew in double digits, outpacing productivity and faster than most EU countries.
- Policy stance and transmission:
  - Over "2020–22," both fiscal and monetary stances were among the most expansionary in the EU; cyclically-adjusted fiscal balances and real interest rates were below most peers.
  - A normalized policy stance index combining the fiscal balance and the real policy rate indicates the overall policy mix between "2020 and 2022" was the loosest in over two decades, and remained loose even as unemployment fell and inflation accelerated.
  - The MNB began raising policy rates in mid-2021 but continued adding liquidity through asset purchases until end-2021.
- Exchange rate passthrough:
  - The forint depreciated against the US dollar in 2022 by more than most emerging market currencies.
  - Past estimates: passthrough in emerging markets around "6 percent in the first month and around 20 percent after about one year"; for Hungary estimates include "up to 30 percent after two years (Hajnal 2015)" and "10–20 percent after two years (Vonnák 2010)."
  - Updated analysis suggests passthrough to inflation has increased, with potential non-linearities and asymmetries (larger passthrough for depreciations and for larger shocks).

### D. Outlook and risks
- IMF staff baseline projections:
  - Headline and core inflation are expected to peak in early 2023, then slow as commodity prices retreat, the policy mix tightens, and high inflation erodes households’ purchasing power.
  - Core inflation is expected to remain elevated and above the MNB’s target until "end-2025."
- Main quantified risks to inflation (Phillips Curve simulation; Appendix II shock descriptions preserved):
  - Increased persistence (more backward or less forward-looking expectations and wage-price dynamics) could add up to "3 percentage points to core inflation in 2023."
  - Tighter-than-expected labor markets could add up to "2 percentage points to core inflation in 2023."
  - De-anchored inflation expectations are a clear risk but historically have been relatively well-anchored around the central bank’s target, implying somewhat less potency relative to persistence and labor-market risks.
- Illustrative risk scenarios (labels and shocks preserved):
  - Scenario 0 Baseline (WEO): "July WEO GAS (energy inflation 69% in 2022, -14.1% in 2023; food inflation 19% in 2022, 2.8% in 2023)"; cost shock raises inflation to WEO baseline in 2022Q2.
  - Scenario 1 Negative supply shocks: "20 percent rise in energy and food prices"; additional inflationary cost shock matching initial shock.
  - Scenario 2 Positive supply shocks: "20 percent fall in energy and food prices"; deflationary cost shock matching initial shock.
  - Scenario 3 Looser labor market: "2 percentage points lower unemployment gap"; "2 percentage points lower output gap than assumed in monetary policy rule."
  - Scenario 4 Tighter labor market: "2 percentage points higher unemployment gap"; "2 percentage points higher output gap than assumed in monetary policy rule."
  - Scenario 5 Inflation expectations de-anchored: "1 percentage point higher expected inflation"; expectations increase inflation in the first period by "1 percentage point."
  - Scenario 6 Increased persistence (Wage-price spiral): "A rise in the coefficient on lagged inflation to 0.95"; "A rise in the coefficient on lagged inflation to 0.8."
  - Note: "All shocks persist throughout the simulation periods of 6 quarters in the Phillips curve simulation exercise."

### E. Policy implications (high-level findings and prescriptions)
- Overarching guidance:
  - "A consistently and persistently tight overall policy mix is needed to return inflation to the central bank’s target," given strong domestic demand pressures, tight labor markets, elevated core inflation, and substantial passthrough from producer and energy prices.
  - Policy measures should:
    - Reinforce monetary tightening until inflation expectations and core inflationary dynamics show sustained disanchoring in a downward direction.
    - Coordinate fiscal policy to avoid procyclical loosening that would offset monetary tightening.
    - Monitor and, where feasible, mitigate second-round effects (wage-price dynamics) and exchange rate depreciation episodes that could amplify inflation persistence.
- Shock-specific guidance:
  - Supply shocks that raise inflation: call for tighter monetary policies and fiscal policies that remain tight while making space to support vulnerable groups.
  - Demand shocks that lower both output and inflation: may prompt a less tight stance to support activity while allowing inflation to fall toward target.
- Caps assessment:
  - Price and interest rate caps are "costly, ineffective, and undermine monetary and fiscal policy’s efforts to reduce inflation."
  - Caps prevent the demand adjustment needed to cool underlying pressures, can widen external deficits, cause exchange rate depreciation and higher inflationary pressure, and risk entrenching higher expectations.
  - Interest rate caps "undermine the effectiveness of monetary policy by disconnecting key channels of transmission," potentially requiring greater tightening later.
- Policy trade-offs:
  - "The costs of under-tightening exceed those of over-tightening."
  - On balance, "it seems better to over- than under-tighten to stabilize inflation, re-anchor inflation expectations, and enable a stable environment for recovery."
  - Fiscal consistency is crucial; administrative measures should not undermine policy tightening.
- Timing and persistence:
  - Because of persistence of core inflation and policy lags, maintaining a tight and consistent policy stance with flexibility to respond to future shocks is important.

### F. Summary statistics and notable magnitudes (preserve exact figures)
- Inflation: "2.7 percent y/y in January 2021" → "24.5 percent in December 2022."
- Electricity and gas consumer price inflation jumps: "nearly around 30 and 115 percent y/y, respectively, in September 2022."
- Motor fuels: "27 percent y/y" jump after cap lifted; contributed close to "2 percentage points to headline CPI y/y" in December 2022.
- Producer prices: "nearly 68 percent y/y in October 2022" and "63.7 percent in November 2022."
- Contribution to headline CPI from services and nonenergy, nonfood goods: around "40 percent through December 2022."
- Private sector wages: grew "in double digits" (exact country ranking: faster than most EU countries).
- Policy mix looseness: "2020–22" was the loosest in over two decades per normalized index.
- IMF projection horizon: core inflation above target until "end-2025."

---

### MNB mandate, monetary operations, and unconventional tools

### MNB mandate and institutional trade-offs
- Primary objective:
  - "The primary objective of the MNB shall be to achieve and maintain price stability." (Unofficial English translation of the Law on the MNB: Art. 3 (1)).
  - Without prejudice to price stability, the MNB "shall support the maintenance of the stability of the system of financial intermediation, the enhancement of its resilience, its sustainable contribution to economic growth; furthermore, the MNB shall support the government's economic policy and its policy related to environmental sustainability, using instruments at its disposal." (Art. 3(2), unofficial translation).
- Decision body:
  - The Monetary Council is the MNB’s supreme decision-making body (Art. 9(1) of the MNB Law) and arbitrates trade-offs among competing objectives.
- Trade-offs:
  - Delegating primacy to price stability avoids resolving financial challenges with ample liquidity that would result in inflation.
  - Example trade-off: encouraging longer interest rate fixation to enhance financial stability "impedes the transmission of monetary policy." Monetary Council and Financial Stability Council decide on such trade-offs.

### Quasi-fiscal operations, government schemes, and competing objectives
- MNB credit-supportive initiatives (examples):
  - Funding for Growth Scheme (FGS), purchase of mortgage bonds, Bond Funding for Growth Scheme (BGS), Market-Based Lending Scheme (MLS).
  - Such initiatives "could leave the appearance of quasi-fiscal operations that would be better performed by state-owned development banks, public guarantee schemes, or direct fiscal operations."
- Magnitudes and interactions:
  - Subsidized bank lending (MNB’s FGS and government schemes) amounted to "31 percent of total bank credit to NFC" (higher for SMEs at "44 percent") as of end-September 2022.
  - As of September 2022, about "21.5 percent of bank lending to NFCs are backed by a guarantee from a domestic institution with a counter guarantee from the government."
  - At end-2021, about "a quarter of newly issued housing loans were subsidized by the government."
- Housing and retail instruments:
  - MAP+ retail bond (introduced 2019): simple average annual yield of the 5-year MAP+ was "4.95 percent" vs about "1.6 percent" for a 5-year benchmark government bond in 2019; since February 2022 the benchmark yield exceeded MAP+ yield.
  - Prenatal "baby" loans: maximum loan of "HUF 10 million (about €25,000)" interest free under specified conditions; state assumes "30 percent" of remaining debt in case of two children; government assumes whole remaining debt for three children.
- Debt-service moratoria:
  - Pandemic moratorium changed from opt-out to opt-in in November 2021; participation declined and expired at end-2022. Government announced moratorium for agricultural loans from September 2022 to end-2023.

### Interest rate and deposit caps — transmission disruption
- Interest rate caps on lending:
  - Cap on eligible variable-rate mortgages in place until "end-June 2023" for mortgages with repricing during November 2021 to end-June 2022; later extended to end-June 2023 and broadened to mortgages with up to five years fixation.
  - Temporary interest cap on SME loans till "end-June 2023."
  - These caps "disconnect key channels of monetary policy transmission," can undermine financial stability, raise moral hazard, and reduce bank profitability.
- Deposit rate cap:
  - Interest rate on large retail and large institutional deposits (over "€50,000," till "end-March 2023") cannot exceed the average yield of 3-Month T-bills, currently just below "12 percent."
  - Banks had placed funds with the MNB at up to "18 percent" (the current effective marginal policy rate). The cap reduced yields on treasuries and indirectly on mortgage bonds, undermining monetary policy tightening.

### Evolution of monetary operations since 2013 — five phases
- 2013 to February 2016:
  - Low inflation, monetary easing, measures: Self-Financing Program, FGS, conversion of FX loans, gradual policy rate reduction.
- March 2016 to February 2020:
  - Inflation within tolerance band; accommodative policy; unconventional tools to influence long end of yield curve and develop mortgage/corporate bond markets.
- COVID pandemic (March 2020 to May 2021):
  - Monetary and fiscal policies significantly eased; MNB shifted operational target from excess liquidity to interest rates, provided ample long-term liquidity, suspended reserve requirement penalization, enhanced FGS, introduced asset purchase programs (APPs).
- Recovery (June 2021 to February 2022):
  - Stronger-than-expected recovery, accelerating inflation, monetary tightening; MNB raised policy rates and phased out unconventional tools by end-2021.
- Spillovers from Russia’s war in Ukraine (since February 2022):
  - Further monetary tightening, absorption of liquidity via longer-maturity instruments, enhanced liquidity-absorption tools via daily FX swaps, "higher reserve requirements, and longer MNB deposits," temporary FX sales to importing energy companies.
  - Sizable monetary tightening turned the real-interest rate (deflated by next-year inflation expectations) positive.
- Operational framing:
  - Debate between "one instrument per target" (Tinbergen) and combinations of instruments under stochastic disturbances (Brainard, Turnovsky). Simplicity aids communication; a calibrated range of instruments may be optimal if credibility is maintained.

### Unorthodox instruments and balance-sheet dynamics
- Use and purpose:
  - MNB frequently complemented conventional tools with "unorthodox" instruments to address impaired transmission, perceived market failures, and to strengthen lending channels.
- Notable programs and magnitudes:
  - Funding for Growth Scheme (FGS):
    - Announced April 2013; MNB provided zero interest funding on-lent at up to "2.5 percent," max maturity 10 years.
    - Outstanding FGS loans amounted to about "4.2 percent of GDP at end-November 2022."
    - MNB (2017) notes FGS may have added about "2 percentage points to GDP" and enhanced employment by "around 20,000."
  - Self-Financing Program (SFP) (April 2014–April 2016):
    - Banks increased government securities portfolio by almost "6 percentage points of GDP."
    - Reduced externally held public debt by over "€9 billion."
    - Reduced share of FX denominated debt from about "50 to below 30 percent."
  - Asset Purchase Programs (APPs):
    - Mortgage APP (2018; relaunched April 2020), Corporate bond APP/BGS (announced April 2019; launched July 2019), Government securities APP (2020).
    - Pre-pandemic purchases: about "1.2 percent of GDP."
    - Pandemic purchases (till end-2021): additional "9.1 percent of GDP."
    - MNB bought government bonds for about "6.4 percent of (2021) GDP in total."
    - Mortgage bond purchases during pandemic: about "0.6 percent of GDP"; 2018 purchases about "0.9 percent of GDP."
    - BGS purchases early May 2020–end-April 2021: about "0.9 percent of GDP," of which almost "0.7 percent of GDP" was in the primary market.
- Balance-sheet caveats:
  - Size of the balance sheet does not capture off-balance-sheet items (e.g., interest rate swaps). Observed MNB balance sheet declined early in the period, stabilized, then grew rapidly during the pandemic.

### Transmission channels and recent effectiveness
- Main channels: (i) interest rate channel (credit and cost), (ii) asset price/balance sheet channel, (iii) exchange rate channel, (iv) expectation channel.
- Interest rate channel notes:
  - Policy rate increases affected banks’ lending rates with a lag, but much less deposit rates, particularly household demand deposits.
  - Contributing factors: ample liquidity (loan-to-deposit rate about "83.4 percent in September 2022") and rigidity of small depositors.
  - Competition for large depositors intensified; interest rate caps impede the interest channel and may require even tighter operations.
- Asset price channel notes:
  - Residential ownership about "91.3 percent in 2020" vs "70.0 percent for the EU-27 average."
  - MNB housing-model simulation: an increase of the policy rate of about "465 bp" would likely decrease housing prices by about "2 percentage points in the Budapest area and 4 percentage points in the rural areas."
  - Stock market capitalization about "17.8 percent of GDP in 2020"; BUX dominated by three companies accounting for "87.6 percent of the BUX."
- Exchange rate channel notes:
  - Pass-through heterogeneous and non-linear; empirical estimates for Hungary: a one percent depreciation raised inflation by about "0.30 percent after two years" (Hajnal et al., 2015); pass-through declined to "about 0.10 to 0.20 percent after the GFC" in some estimates.

### Credit channel, collateral and financial accelerator
- Loan-to-deposit ratio history:
  - "147 in October 2009," "113 in January 2013," "83 in September 2022."
- FGS, BGS and long-term collateralized lending aimed to reinstate the credit channel after deleveraging.
- Household debt and housing:
  - Household debt relatively low; only about half of residential real estate transactions financed by bank credit.
  - Large role of foreign demand and relatively large saving by wealthier Hungarian households in financing real estate.

### Conclusions and lessons
- Changes in monetary operations since 2013 have been within MNB’s statutory mandate; preferences and constraints evolved and transmission channels developed accordingly.
- Key lessons:
  - Simplicity and transparency have value; temporary, well-calibrated unconventional tools can help, but excessive complexity risks blurring policy signals and harming credibility.
  - The case for addressing market failures must be weighed against risks of public sector failure and quasi-fiscal appearances.
  - Prompt interventions to solve immediate challenges can have long-term consequences (e.g., ample long-term liquidity during the pandemic created negative externalities visible during recovery).
  - MNB should continue to communicate the positive and negative externalities of the overall policy mix so markets can make informed decisions.

*Prepared by IMF staff (January 17, 2023).*

### 1. Inflation in Hungary and Europe ____________________________________________________ 3

### 1. Inflation in Hungary and Europe

### A. Overview and Recent Developments
- Inflation accelerated from 2.7 percent y/y in January 2021 to 24.5 percent in December 2022.
- Common external shocks (COVID-related supply disruptions, surge in commodity prices, Russia’s war in Ukraine) lifted inflation across Europe; Hungary’s inflation rose to notably higher levels than all other European countries.
- Multiple shocks and policy responses since 2020 reinforced inflationary pressures:
  - Extraordinary fiscal and monetary loosening in 2020 to respond to COVID-19.
  - Additional fiscal stimulus ahead of the April 2022 elections.
  - Widening external deficit led by high energy prices and sustained demand.
  - Tighter global financial conditions and disputes with the EU that intensified exchange rate and imported inflation pressures.
- By mid-2022 the fiscal-monetary policy mix began to tighten as fiscal policy reversed course and aligned with monetary policy.

### B. Composition of Inflation
- Food inflation:
  - Food inflation in Hungary is the highest in the EU.
  - A 2022 drought curtailed agricultural production, adding pressure on unprocessed food prices; strong passthrough from unprocessed to processed foods and low productivity in food processing contributed to exceptionally high processed food inflation.
  - The government introduced price caps in February 2022 on specific food products at their October 15, 2021 levels; caps were extended, expanded (eggs and potatoes), and are set to expire in April 2023. The caps were ineffective in slowing food inflation as distributors and retailers raised prices on other products.
- Energy and fuels:
  - Household energy utility price caps in place since 2014 initially shielded households from wholesale price increases; an August 2022 adjustment increased the cap for consumption above the national average, exposing around one quarter of households to higher energy utility prices.
  - After the August 2022 change, electricity and gas consumer price inflation jumped from zero to nearly around 30 and 115 percent y/y, respectively, in September 2022, jointly contributing close to 3 percentage points to headline CPI y/y that month and remaining around similar levels through December 2022.
  - Motor fuels price cap (November 15, 2021 to December 6, 2022) was lifted in December 2022; fuel prices jumped by 27 percent y/y and contributed close to 2 percentage points to headline CPI y/y that month.
- Producer prices:
  - Domestic producer price inflation reached nearly 68 percent y/y in October 2022 and declined slightly to 63.7 percent in November 2022, led by energy and intermediate good prices.
  - A historically high correlation between producer and consumer prices suggests much of the passthrough of higher production costs has already occurred.
- Core inflation:
  - Core inflation measures (excluding unprocessed food or both unprocessed and processed foods) are highest in the EU.
  - Services and nonenergy, nonfood goods inflation contributed around 40 percent of headline CPI inflation through December 2022.
  - Services inflation accelerated into double-digit territory and nonenergy, nonfood goods inflation rose faster than peer Emerging Europe countries.

### C. Inflation Drivers — Models, Labor Market, and Policy
- Phillips Curve estimates (panel of 21 advanced and 5 emerging European economies, 2000Q1–2022Q2):
  - Past core inflation and three-year ahead inflation expectations are important drivers of current core and headline inflation in Hungary.
  - External price pressures (commodity food and energy prices, foreign producer prices, exchange rates) are statistically significant drivers.
  - The unemployment gap coefficient (based on historical trends) is statistically insignificant for Hungary over the full sample, similar to Bulgaria, Croatia, and Poland—but the relationship may have changed in the last two years.
- Labor market tightness and wages:
  - Since 2020:Q2, core inflation has become more correlated with the unemployment rate than pre-COVID.
  - Labor market tightness (ratio of job vacancies to the unemployment rate) rose to historically high levels, indicating historically low labor market slack.
  - Private sector wages grew in double digits, outpacing productivity growth and faster than most EU countries.
- Policy stance:
  - Over 2020–22, both fiscal and monetary stances were among the most expansionary in the EU; cyclically-adjusted fiscal balances and real interest rates were below most peers.
  - A simple normalized policy stance index combining the fiscal balance and the real policy rate indicates the overall policy mix between 2020 and 2022 was the loosest in over two decades, and remained loose even as unemployment fell and inflation accelerated.
  - The MNB began raising policy rates in mid-2021 but continued adding liquidity through asset purchases until end-2021.
- Exchange rate passthrough:
  - The forint depreciated against the US dollar in 2022 by more than most emerging market currencies.
  - Past literature indicates exchange rate passthrough in emerging markets of around 6 percent in the first month and around 20 percent after about one year; estimates for Hungary include up to 30 percent after two years (Hajnal 2015) and 10–20 percent after two years (Vonnák 2010).
  - Updated analysis suggests passthrough to inflation has increased, with potential non-linearities and asymmetries (larger passthrough for depreciations and for larger shocks).

### D. Outlook and Risks
- IMF staff baseline projections:
  - Headline and core inflation are expected to peak in early 2023, then slow as commodity prices retreat, the policy mix tightens, and high inflation erodes households’ purchasing power.
  - Core inflation is expected to remain elevated and above the MNB’s target until end-2025.
- Main risks to the inflation outlook and quantified impacts (model simulation using estimated Phillips Curve; see Appendix II for shock descriptions):
  - Increased persistence of inflation (more backward or less forward-looking expectations and wage-price dynamics) could add up to 3 percentage points to core inflation in 2023.
  - Tighter-than-expected labor markets could add up to 2 percentage points to core inflation in 2023.
  - De-anchored inflation expectations are a clear risk but historically have been relatively well-anchored around the central bank’s target, implying somewhat less potency relative to persistence and labor-market risks.

### E. Policy Implications (high-level findings)
- A consistently and persistently tight overall policy mix is needed to return inflation to the central bank’s target, given:
  - Strong domestic demand pressures linked to loose policies in 2020–22.
  - Tight labor markets and wage growth outpacing productivity.
  - Elevated core inflation and substantial passthrough from producer and energy prices.
- Policy measures to address inflation should aim to:
  - Reinforce monetary tightening until inflation expectations and core inflationary dynamics show sustained disanchoring in a downward direction.
  - Coordinate fiscal policy to avoid procyclical loosening that would offset monetary tightening.
  - Monitor and, where feasible, mitigate second-round effects (wage-price dynamics) and exchange rate depreciation episodes that could amplify inflation persistence.

*Prepared by IMF staff (January 17, 2023).*

### 15.      Expansionary policies and external shocks boosted Hungary’s inflation. Hungary’s high

### 15.      Expansionary policies and external shocks boosted Hungary’s inflation. Hungary’s high

### Drivers of inflation
- Supply-side drivers:
  - "Unprecedented spikes in commodity prices significantly affected food prices."
  - Energy retail inflation was "repressed until recently" but "has begun to pass through and will soon create additional inflation pressures."
- Demand-side drivers:
  - "Significant fiscal policy stimulus, strong domestic demand, tight labor markets, and rapid wage growth contributed to increasing core inflation."
  - "Second-round effects from energy prices" amplified core inflation.
  - "Core inflation’s own persistence reinforced its strong dynamics."

### Policy prescriptions to reduce inflation
- Overarching approach:
  - "Credible, persistent, and consistently tight economic policies are needed to reduce inflation and drive it towards its target."
  - "Fiscal and monetary policies need to remain consistently tight and complement each other in dampening demand and reining in inflation."
  - "The exchange rate should remain free to adjust as needed while fiscal and monetary policies should remain persistently tight over time."
  - "Changes in the policy stance should depend on actual data on underlying inflationary pressures and the nature of any future shocks."
- Shock-specific guidance:
  - Supply shocks that increase inflation:
    - "Call for tighter monetary policies and for fiscal policies to remain tight while making space to support vulnerable groups impacted by higher costs of living."
  - Demand shocks that lower both output and inflation:
    - "May prompt a less tight stance to support economic activity while allowing inflation to fall towards the target range."
- Timing and persistence:
  - "Due to the persistence of core inflation and to lags between policy actions and an ultimate impact on inflation, maintaining a tight and consistent policy stance, with flexibility in responding to future shocks, is important to ensure that inflationary pressures consistently and sustainably ease."

### Assessment of price and interest rate caps
- Core findings:
  - "Price and interest rate caps are costly, ineffective, and undermine monetary and fiscal policy’s efforts to reduce inflation."
- Mechanisms of harm:
  - "Sustaining artificially low prices prevents the demand adjustment that is needed to cool underlying pressures."
  - Caps "have not been effective in fighting inflation" — e.g., "price caps on selected food produces have resulted in higher prices on other products to compensate losses."
  - Energy price caps "have prevented demand adjustment and led to wider external deficits and greater exchange rate depreciation which, in turn, increased inflationary pressure."
  - Caps are "not sustainable" and "will eventually need to be removed," illustrated by the motor fuel price cap that "was abruptly terminated on December 6, 2022 after it had led to widespread fuel shortages."
  - By "delaying the inevitable inflationary impact, price caps risk ultimately entrenching expectations higher, for longer."
  - Interest rate caps "undermine the effectiveness of monetary policy by disconnecting key channels of transmission, eventually requiring greater tightening to achieve the same outcome."

### Policy trade-offs under high uncertainty
- Comparative costs:
  - "The costs of under-tightening exceed those of over-tightening."
  - Potential costs of under-tightening include "entrenched high inflation and a higher eventual cost of controlling it."
  - "On balance, it seems better to over- than under-tighten to stabilize inflation, re-anchor inflation expectations, and enable a stable environment for recovery."
- Fiscal consistency:
  - "To best complement monetary policy in its efforts to support the inflation target, the consistency of fiscal policy is crucial while administrative measures should not undermine policy tightening."

### Model results and illustrative risk scenarios
- Phillips Curve model (summary of relevant covariates and findings in Appendix I):
  - Variables with statistically significant coefficients (examples preserved as described):  
    - "Unemployment Gap" coefficients reported across panels (e.g., -0.374***, -0.676***, -0.337***, -0.259, -0.207, -0.361, -0.139-0.477).
    - "Lag of Core Inflation" coefficients (e.g., 0.431***, 0.581***, 0.287*, 0.807***, 0.786***, 0.723***, 0.920***, 0.426***).
    - "Inflation Expectations: 3 Years Ahead" coefficients (e.g., 0.569***, 0.419***, 0.713***, 0.193**, 0.214*, 0.277**, 0.0800.574***).
    - "Lag of External Price Pressure" coefficients (e.g., 0.020***, 0.037**, 0.009*, 0.0160.0540.061***0.010-0.023).
    - Food and energy price coefficients and lags are reported in detail (e.g., Food price 0.127***, 0.181***, 0.065***, -0.0030.028-0.0420.042**0.109***; Energy Price 0.0160.0210.032***0.0580.0480.053*0.028*-0.035).
  - Observations by panel: "2,210 503 1,707 6060 868686" (as presented).
  - "Robust standard errors in parentheses. *** p<0.01, ** p<0.05, * p<0.1."
- Illustrative inflation risk scenarios (Table A.II; labels and shocks preserved):
  - Scenario numbering and shocks:
    - 0 Baseline (WEO): "July WEO GAS (energy inflation 69% in 2022, -14.1% in 2023; food inflation 19% in 2022, 2.8% in 2023)"; "Cost shock raises inflation to WEO baseline in 2022Q2."
    - 1 Negative supply shocks: "20 percent rise in energy and food prices"; "Additional inflationary cost shock matching initial shock in Phillips curve simulation."
    - 2 Positive supply shocks: "20 percent fall in energy and food prices"; "Deflationary cost shock matching initial shock in Phillips curve simulation."
    - 3 Looser labor market (More slack than estimated): "2 percentage points lower unemployment gap"; "2 percentage points lower output gap than assumed by in monetary policy rule."
    - 4 Tighter labor market (Less slack than estimated): "2 percentage points higher unemployment gap"; "2 percentage points higher output gap than assumed in monetary policy rule."
    - 5 Inflation expectations de-anchored: "1 percentage point higher expected inflation"; "Inflation expectations increase inflation in the first period by 1 percentage point."
    - 6 Increased persistence (Wage-price spiral): "A rise in the coefficient on lagged inflation to 0.95"; "A rise in the coefficient on lagged inflation to 0.8."
  - Note: "All shocks persist throughout the simulation periods of 6 quarters in the Phillips curve simulation exercise."

### Summary of recent monetary operations and phases since 2013
- Institutional targets and parameters:
  - MNB medium-term headline inflation target: "3 percent", with an inflation-tolerance band "2–4 percent" since March 2015.
  - Communication focus shifted between "core inflation excluding indirect taxes" and "headline"; "Core inflation has exceeded headline since March 2022."
- Five broad phases of monetary operations since 2013:
  - 2013 to February 2016:
    - Characterized by "low inflation, monetary easing, and efforts to reduce vulnerabilities and re-leverage the economy."
    - Policies included Self-Financing Program, Funding for Growth Scheme (FGS), conversion of FX loans to local currency, and gradual reduction of policy rates.
  - March 2016 to February 2020:
    - "Inflation largely hovered in the inflation tolerance band"; monetary policy "remained accommodative."
    - New unconventional tools introduced to: "(i) influence the long end of the yield curve (the MNB offered interest rate swaps); (ii) develop the mortgage bond market (MNB purchases of mortgage bonds, introduced new mortgage-bond indices at the Budapest Stock Exchange); and (iii) promoted the market for corporate bonds by the MNB’s Bond Funding for Growth Scheme (BGS)."
    - Some unconventional tools removed by end-2018.
  - COVID pandemic (March 2020 to May 2021):
    - "Monetary and fiscal policies were significantly eased."
    - MNB overhauled toolkit, changed operational target from excess liquidity to interest rates, provided "ample long-term liquidity," suspended reserve requirement penalization, enhanced FGS, introduced an asset purchase program (APP) of government securities in the secondary market, reactivated APP of mortgage bonds, and eased APP of corporate bonds.
    - "After an initial depreciation, the exchange rate stabilized."
  - Recovery (June 2021 to February 2022):
    - "Recovery was stronger than expected, inflation began to accelerate, and monetary policy tightened."
    - Drivers included "increasing commodity prices, supply chain shortages, etc." and "an expansionary fiscal policy up to the April 2022 elections."
    - MNB raised policy rates and "gradually phasing-out its unconventional tools, which was achieved by end-2021."
  - Spillovers from Russia’s war in Ukraine (since February 2022):
    - Necessitated "further monetary policy tightening, including through absorption of liquidity by instruments with longer maturities to counter depreciation pressures."
    - Actions included enhanced liquidity-absorption tools via daily FX swaps (instead of quarterly), "higher reserve requirements, and longer MNB deposits," and temporary FX sales directly to importing energy companies.
    - "The sizable monetary tightening turned the real-interest rate (deflated by next-year inflation expectations) positive."
- Framing of policy instrument debate:
  - Trade-offs between "one instrument per target" (Tinbergen) versus combinations of instruments given stochastic disturbances (Brainard, 1967; Turnovsky, 1977).
  - "Rule versus Discretion" considerations: discretion may be optimal if central bank is credible (Buiter, 1981); otherwise contingent rules may be preferable.
  - Simplicity aids communication and reduces credibility risk, but a well-calibrated range of instruments may be optimal if credibility is maintained.

*Source: IMF staff summarization of the Hungary staff report chapter and appendices as provided in the supplied content.*

### 7.      The primary objective of the MNB is to achieve and maintain price stability. Without

### 7.      The primary objective of the MNB is to achieve and maintain price stability. Without

### MNB mandate and institutional framework
- Primary objective: “The primary objective of the MNB shall be to achieve and maintain price stability.” (Unofficial English translation of the Law on the MNB: Art. 3 (1)).
- Without prejudice to its primary objective, the MNB “shall support the maintenance of the stability of the system of financial intermediation, the enhancement of its resilience, its sustainable contribution to economic growth; furthermore, the MNB shall support the government’s economic policy and its policy related to environmental sustainability, using instruments at its disposal.” (Art. 3(2), unofficial translation).
- The Monetary Council is the MNB’s supreme decision-making body (Art. 9(1) of the MNB Law) and arbitrates trade-offs among potentially competing objectives within the MNB mandate.
- The MNB is independent and cannot provide direct credit to the government (per EU Treaty and Art. 21 in the Statutes of the ECB and ESCBs), yet it can balance objectives “without prejudice to price stability.”

### Trade-offs between price stability and financial stability
- The institutional framework delegates primacy to price stability to avoid resolving financial sector challenges by providing ample liquidity that would ultimately result in inflation.
- Example trade-off: reducing the share of variable-rate mortgages by encouraging longer interest rate fixation periods enhances financial stability but “impedes the transmission of monetary policy.” The Monetary Council decides on this trade-off together with the Financial Stability Council.
- Historical judgment: mid-2021 to May 2022—MNB tightened policy rates, phased out unconventional tools, and advised against expansionary fiscal policy, but was slower than peers to stop purchases of government securities. With hindsight, the MNB considers that a faster exit from the government security purchase program would likely have been beneficial but notes high uncertainty around the post-covid recovery justified caution.

### MNB interventions with quasi-fiscal appearance and implications for monetary transmission
- MNB has implemented initiatives to boost intermediation in priority sectors (e.g., Funding for Growth Scheme (FGS), purchase of mortgage bonds) citing market failures; such measures influenced funding costs and encouraged market segmentation to avoid arbitrage.
- These initiatives “could leave the appearance of quasi-fiscal operations that would be better performed by state-owned development banks, public guarantee schemes, or direct fiscal operations.” Examples of state actors: Hungarian Development Bank (MFB), Exim Bank, Garantiqa Hitelgarancia Zrt. (owned by MFB).

### Competing operations and targets of the MNB and the government — key findings
- Traditional division of labor: central bank anchors the short end of the yield curve and influences inflation expectations; government shapes risk along and within yield curve segments.
- MNB Governor is a member of the Fiscal Council to help resolution; transparent information is critical.

- Specific competing objectives or inconsistent policies:
  - Subsidized bank lending (MNB’s FGS and various government schemes) amounted to 31 percent of total bank credit to NFC (even higher for SMEs at 44 percent) as of end-September 2022.
  - As of September 2022, about 21.5 percent of bank lending to NFCs are backed by a guarantee from a domestic institution with a counter guarantee from the government.
  - Housing support: at end-2021, about a quarter of newly issued housing loans were subsidized by the government (MNB’s Financial Stability Report, May 2022).
    - Housing benefit scheme introduced in 2016 (grant and subsidized interest rates); rural housing scheme introduced in 2019.
    - Preferential VAT rate of 5 percent instead of 27 percent applied to sales of newly constructed residences not exceeding a certain size during 2016-19 and 2022-27.
    - Prenatal “baby” loans introduced in mid-2019 and extended to end-2024: maximum loan of HUF 10 million (about €25,000) is interest free if the family has one child within five years; state assumes 30 percent of remaining debt in case of two children; government will take over the whole remaining debt in case of three children.
    - Program to refurnish housing introduced in 2021 and extended in 2022.
    - MNB introduced and adjusted macroprudential policies for housing and promoted long-term mortgage bonds.
  - MAP+ retail bond introduced in 2019 initially offered above market yields. The simple average annual yield of the 5-year MAP+ was 4.95 percent, compared to about 1.6 percent (average during 2019) of a 5-year benchmark government bond in the market. Since February 2022, the yield of the 5-year benchmark has exceeded yield of MAP+.
    - MAP+ and other retail bonds can be redeemed before their 5-year maturity; retail/wholesale segmentation affects yield curve slope and transmission of monetary policy.
  - Debt-service moratorium after the pandemic was extended several times and changed from opt-out to opt-in in November 2021; participation declined and expired at end-2022. Government announced moratorium for agricultural loans from September 2022 to end-2023.
    - Continued extensions risk raising moral hazard and artificially increasing future net interest margins.
  - Climate and energy measures: government supported energy insolation, stricter energy standards for new constructions since 2019 for public buildings and 2021 for other buildings, and incentives for solar and wind. MNB’s green initiatives aim to reduce environmental risk costs of bank lending to green projects and support green mortgages as part of its APP. In 2012/13, significant subsidies of household utilities likely delayed energy-saving investments; utility subsidy was reduced for above average consumption only in September 2022.

### Interest rate caps and disruption of monetary transmission
- Government introduced temporary interest rate caps on lending rates:
  - Cap on eligible variable-rate mortgages in place until end-June 2023. Eligible mortgages with interest rate repricing during November 2021 to end-June 2022 were frozen for the first half of 2022 at the October 2021 level. Cap later extended to end-June 2023 and scope broadened to mortgages with up to five years interest rate fixation periods.
  - Temporary interest cap on SME loans till end-June 2023.
  - These caps “disconnect key channels of monetary policy transmission,” can undermine financial stability, raise moral hazard, incentivize risky behaviors, and reduce bank profitability. Targeted assistance to the neediest borrowers would likely be more efficient and less distortive.
- Government introduced interest rate caps on large deposits:
  - Interest rate on large retail and large institutional deposits (over €50,000, till end-March 2023) cannot exceed the average yield of 3-Month T-bills, which currently is just below 12 percent.
  - Banks had placed funds with the MNB at up to 18 percent (the current effective marginal policy rate). The cap promptly reduced yields on treasuries and indirectly on mortgage bonds, undermining monetary policy tightening.

### Hungarian monetary operations since 2013 — overview and evolution
- Early period: MNB used conventional tools for price stability and then introduced unconventional tools to address consequences of the GFC, contain vulnerabilities, and re-leverage the economy; liquidity impact often sterilized.
- Middle period: focus on liquidity management to maintain money market rates close to the floor of the interest rate corridor; attempts to directly influence the longer end of the yield curve.
- Pandemic: additional long-term liquidity provided using unconventional tools; MNB refocused operations on interest rates while providing ample long liquidity.
- Mid-2021 onward: gradual tightening as recovery proved stronger than expected; “overhang” of liquidity absorbed mainly by short-term instruments.
- October 2022: to make it more expensive to shorten the currency, MNB tightened both price (policy rates) and quantity (longer liquidity absorbing instruments).

### Policy and money market rate dynamics
- Policy rates may not always be the best yardstick to gauge monetary stance in Hungary; the base rate has often been mainly a signaling rate.
- 3-month BUBOR is the “go-to” indicator to appraise the impact on inflation of interest rate changes and accounts better for expectations and structural liquidity changes.
- Historical operational adjustments: floor of the interest corridor became slightly negative at times; ceiling reduced to level of base rate; excess liquidity became an intermediate operational target to keep short money market rates slightly positive and avoid excess exchange rate and capital flow volatility.

### Liquidity management practices and instruments
- MNB used a variety of instruments to absorb and provide liquidity, for example:
  - Providing long-term liquidity while absorbing excess liquidity with shorter instruments to ease concerns about future liquidity squeezes.
  - Preferential deposits with the MNB to incentivize behaviors.
  - Adjusting eligibility of collateral for standing and emergency facilities.
- Pandemic-period measures included:
  - Increasing liquidity-providing FX swaps.
  - Introducing regular long-term collateralized loan tenders (maturities from 3 months to 5 years at the policy rate).
  - Broadening collateral eligibility by almost 5.5 percent of GDP to include performing corporate bank loans with a standard haircut of 30 percent, irrespective of maturity and currency.
  - Temporarily suspending penalties of deficient reserve requirements.
  - Absorbing excess liquidity via regular auctions of 1-week deposits.
  - Increasing overnight overdraft rate so the interest corridor became symmetrical around the base rate, allowing higher money market rates without initially changing the base rate.

*Source: IMF staff synthesis of section titled “7.      The primary objective of the MNB is to achieve and maintain price stability. Without” from 1hunea2023002.*

### 19.      The MNB has frequently complemented its conventional tools with “unorthodox”

### 1hunea2023002 - 19.      The MNB has frequently complemented its conventional tools with “unorthodox”

### Overview of unorthodox instruments and balance sheet dynamics
- The MNB has frequently complemented its conventional tools with “unorthodox” instruments to incentivize credit institutions and strengthen transmission when it deemed it impaired.
- Purpose: mitigate perceived risks and uncertainties along and within segments of the yield curve, mitigate alleged market failures, and strengthen the lending channel (MNB, 2019, page 5).
- Early period: MNB carefully sterilized the liquidity impact of its various programs.
- Post-pandemic: MNB expanded the use of unconventional tools, based on experiences from large-advanced economies that found such tools effective if clearly explained, temporary, and not reintroducing fiscal dominance.
- Caveat on balance-sheet proxies: size of central bank balance sheet is occasionally used as a proxy for extent of unconventional measures but does not capture off-balance sheet items, such as interest rate swaps.
- Observed balance-sheet path: MNB balance sheet declined at the beginning of the analyzed period, then stabilized, and grew rapidly during the pandemic.

*Notable quoted observation in source footnote: “Well, the problem with QE is it works in practice, but it doesn't work in theory” and later: “… in retrospect it has become evident that the costs and risks attributed to the new tools, when first deployed, were overstated.”*

### Funding for Growth Scheme (FGS)
- Objective: encourage inexpensive local-currency bank lending to credit-constrained SMEs and micro enterprises.
- Initial announcement: April 2013.
- Main features:
  - MNB provided zero interest funding to be on-lent against collateral at a maximum of 2.5 percent, with a maximum maturity of 10 years.
  - Aimed to facilitate conversion of FX denominated loans and encourage banks to reduce foreign funding.
  - Liquidity impact was generally absorbed by allowing participating banks to place excess liquidity with the MNB at preferential rates.
- Effectiveness and impacts:
  - Endresz et al. (2015) found the FGS effectively supported investments that would not otherwise have happened.
  - MNB (2017, page 7) notes the FGS, in its various forms during 2013 and 2016, may have added about 2 percentage points to GDP and enhanced employment by around 20,000.
  - Outstanding amount of various FGS loans amounted to about 4.2 percent of GDP at end-November 2022.
- Evolution:
  - Several refinements made to tailor lending.
  - As growth and leveraging recovered, FGS was phased out and complemented by the Market-Based Lending Scheme (MLS).
  - During the pandemic the program was reshaped and later retailored to support the greening of the economy.
- Risk/characterization: tailored support could be perceived as quasi-fiscal activity, particularly when MNB accepted part of the credit risk for a very short period.

### Self-Financing Program (SFP)
- Objective: incentivize banks to move excess liquidity with the MNB into government securities and reduce external vulnerabilities of government debt.
- Duration: April 2014 to April 2016 (then phased out).
- Mechanism: made MNB liquidity absorbing instruments less liquid compared to government securities (maturities increased, tradability and eligibility reduced, auctions reduced).
- Outcomes and magnitudes:
  - Banks increased their portfolio of government securities by almost 6 percentage points of GDP.
  - It coincided with a declining spread vis-à-vis German bunds.
  - Reduced externally held public debt by over €9 billion.
  - Reduced share of FX denominated debt from about 50 to below 30 percent.
  - Contributed to a rating upgrade and lowered government financing costs (Csávás and Kollarik, 2016).
- Liquidity neutrality: to the extent reduction of MNB liquidity absorption matched banks’ purchases of government securities, liquidity impact was neutralized.
- Additional effects: facilitated maturity extension of banks’ bond portfolios and likely improved market liquidity.

### Asset Purchase Programs (APPs)
- Timelines and scope:
  - Mortgage APP introduced 2018.
  - Corporate bond APP introduced 2019 (Bond Funding for Growth Scheme, BGS).
  - Government securities APP introduced 2020.
- Aggregate purchase amounts:
  - Before the pandemic, MNB had purchased securities for about 1.2 percent of GDP.
  - During the pandemic till end-2021 (when these programs expired), MNB bought bonds for an additional 9.1 percent of GDP.
- Purposes: spur development of mortgage and corporate bond markets; alleviate market dysfunction during COVID crisis; ensure liquidity support and later ease government funding costs.
- Timing and policy consistency: continuation of APPs after mid-2021 appears not to have been consistent with MNB’s rate increases as inflation was taking off.

Subprogram specifics
- Government securities APP:
  - Purchases conducted only in the secondary market and in longer maturities.
  - Initial per-issuance limit: 33 percent; later increased to 50 percent; limit abolished in March 2021.
  - Late summer 2020: scope extended to include government guaranteed bonds (state-owned Exim Bank and Hungarian Development Bank).
  - Most government bonds (about 60 percent) bought at weekly tenders; remainder bilateral trades.
  - Program continued longer than some peers and purchases were gradually reduced from August 2021 until stopping in December 2021.
  - MNB bought government bonds for about 6.4 percent of (2021) GDP in total.
  - MNB has not expressed intention to sell these bonds as part of quantitative tightening (at time of source).
- Mortgage bond APP:
  - Initial program active December 2017–December 2018.
  - Relaunched April 2020 with first purchases in May 2020 to alleviate market dysfunction and protect progress.
  - Mid-November 2020: MNB stated it would only buy green mortgages in the secondary market.
  - During the pandemic MNB purchased mortgage bonds for about 0.6 percent of GDP.
  - Note: MNB purchases of mortgage bonds during 2018 amounted to about 0.9 percent of GDP (chart note).
- Corporate bond APP (BGS):
  - Announced April 2019; launched July 2019; first purchases September 2019.
  - Eligible: HUF denominated bonds issued by Hungarian non-financial corporations with initial maturities 3 to 10 years (doubled to 20 years at beginning of the pandemic).
  - Issuer rating requirement: at least B+.
  - Initial maximum exposure to one business group: HUF 20 billion (about €61.5 million); later increased to HUF 50 billion (about €143 million).
  - Purchase share limits: up to 70 percent of an issuance in primary and secondary markets; later limited up to 50 percent in the secondary market.
  - From early May 2020 to end-April 2021, MNB bought corporate bonds for about 0.9 percent of GDP, of which almost 0.7 percent of GDP was in the primary market.
  - BGS expired in December 2021, with a few transactions finalized in April 2022.

### Transmission mechanism: changing effectiveness and channels
- General: transmission mechanism changes over time; monetary operations need to adjust accordingly. Prior remains that tighter monetary policy tends to contract output and contain inflation (when driven by demand), and vice versa.
- Empirical observation: correlation of impact of a change in the 3-month BUBOR rate on real growth and core inflation appears to have become markedly weaker after the GFC; the period was characterized by low and stable interest rates, recovery, and introduction of several subsidized lending programs.
- Main transmission channels (distinct but overlapping):
  - (i) Interest rate channel, including (a) credit and (b) cost channels.
  - (ii) Asset price or balance sheet channel.
  - (iii) Exchange rate channel.
  - (iv) Expectation channel.

Interest rate channel specifics
- Mechanism: interest rate affects intertemporal choices of investment and consumption and hence activity and price levels; hinges on short-term price and nominal wage stickiness.
- Near zero lower bound: further lowering of interest rate may still be expansionary as it contributes to inflation and lowers the real interest rate.
- Recent Hungarian experience:
  - Recent policy rate increases have affected banks’ lending rates with a lag, but much less deposit rates, particularly demand deposits of households.
  - Contributing factors: still ample liquidity in the banking system (loan-to-deposit rate about 83.4 percent in September 2022) and rigidity of small depositors.
  - Competition for large depositors has intensified.
  - Interest rate caps will further impede the interest channel, which may already be affected by various subsidy schemes.
  - Implication: monetary operations may need to be tightened even further than would otherwise have been the case.

*Italic source: IMF staff summary of chapter content from 1hunea2023002.*

### 30.      The credit channel is attributed to frictions—agency costs and asymmetric

### 1hunea2023002 - 30.

### Credit channel
- The credit channel is attributed to frictions—agency costs and asymmetric information—in credit markets. The FGS, BGS as well as the long-term collateralized lending facilities were aimed at reinstating the credit channel (MNB, 2019), which had suffered during the deleveraging following the GFC.
- Narrow credit-channel (supply of deposits and demand for loans):
  - Loan-to-deposit rate: 147 in October 2009, 113 in January 2013, 83 in September 2022.
  - Attracting deposits was a constraint before the GFC, but is no longer a constraint.
- Cost channel (cost of working capital):
  - Higher in less competitive banking systems and in countries with poorer governance practices.
  - Newly established SMEs without “relationship banking” face higher costs (Jarmuzek and Lybek, 2020).
  - Risk premia were an issue right after the GFC; the FGS and government subsidized credit and guarantee schemes, combined with a strong economic recovery, mitigated this factor.
- Broader credit-channel (collateral / financial accelerator / balance-sheet channel):
  - Right after the GFC, collateral constraints were a dampening factor; recently likely an accelerating factor, though contained by prudential regulation.
  - Bank lending (transactions) to both NFCs and households have in recent years been double-digit until global risks increased in 2022 and credit to households decelerated.

### Asset price channel
- Real estate and financial assets are influenced by monetary operations, affecting wealth and thus consumption and investment.
- Housing and household debt:
  - Residential ownership at about 91.3 percent in 2020, compared to 70.0 percent for the EU-27 average (Eurostat).
  - Hungarian mortgages often constitute the largest debt of most households and, given long maturities, have a profound and persistent impact on savings and consumption decisions.
  - Household debt is relatively low in Hungary compared to peers.
  - Only about half of residential real estate transactions in Hungary are financed by bank credit.
  - Foreign demand and relatively large saving by wealthier Hungarian households contribute to this financing pattern.
- MNB housing-model simulation:
  - An increase of the policy rate of about 465 bp would likely decrease housing prices by about 2 percentage points in the Budapest area and 4 percentage points in the rural areas.
- Capital markets:
  - Stock market capitalization of listed companies was about 17.8 percent of GDP in 2020.
  - The blue-chip stock market index (BUX) is dominated by three large companies (bank, energy, and pharma), which alone currently account for 87.6 percent of the BUX.
  - Evidence that monetary tightening had a negative but not significant impact on the stock market (Rezessy, 2005).

### Exchange rate channel
- Exchange rate depreciation typically makes exports more competitive and imports more expensive, boosting domestic activity, although the immediate current account impact can be temporarily negative (J-curve).
- Pass-through of exchange rate changes to inflation:
  - Pass-through varies over time, is non-linear, depends on depreciation vs. appreciation, and on central bank credibility (Ha et al., 2019).
  - Empirical findings for Hungary:
    - Vonnák (2005): An unanticipated 25 pb increase of the interest rate promptly triggered a 1 percent appreciation of the nominal exchange rate, accompanied by 0.3 percent lower real GDP the first three years and about 0.1 to 0.15 percent lower consumer prices the following three years.
    - Hajnal et al. (2015): A depreciation of one percent led to an increase of inflation by about 0.30 percent after two years; the pass-through declined to about 0.10 to 0.20 percent after the GFC.
  - Correlation analysis confirms depreciations are correlated with higher inflation, particularly after 2-3 quarters, with the impact appearing to have faded after the GFC.

### Conclusion and takeaways
- The many changes of monetary operations by the MNB since 2013 have been within its statutory mandate; preferences and binding constraints have evolved and transmission channels developed accordingly.
- Frequent modifications of monetary operations were driven by concerns about market failures and changing transmission channels; introduction, adjustment, and revocation of tools have been clearly communicated and generally smoothly implemented.
- Key lessons and considerations:
  - Simplicity and transparency carry a premium. Temporary correctly calibrated unconventional tools can be helpful, but excessive modifications and an over-complex set of tools risk blurring monetary policy signaling and harming central bank credibility. Clear and candid communication is critical.
  - The case for addressing market failure must be weighed carefully against the risk of public sector failure. Tailored and frequent interventions should be balanced against potential durable credibility costs.
  - Prompt interventions to solve immediate challenges can have long-term consequences. Example: ample provision of long-term liquidity during the pandemic entailed negative externalities that became visible during the recovery; in addition to hiking rates in October 2022, it became necessary to lengthen the maturity of liquidity-absorbing instruments to make it more costly to speculate against the currency.
  - Continue to complement partial views with more general analysis. The MNB is independent and provides comprehensive explanations of its monetary operations. MNB and government operations can sometimes reinforce or contradict each other (example: MNB’s Self-Financing Program vs. government’s temporary interest rate caps, which impede monetary policy transmission). The MNB should continue to point to positive and negative externalities of the policy mix so markets can make informed decisions.

*International Monetary Fund — Hungary chapter excerpt*

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_Source: https://www.imf.org/-/media/files/publications/cr/2023/english/1hunea2023002.pdf_