## sipea2023005 - 1. Inflation and Monetary Policy Stance

## Source details

**Canonical URL:** [sipea2023005 - 1. Inflation and Monetary Policy Stance](https://www.imf.org/-/media/files/publications/selected-issues-papers/2023/english/sipea2023005.pdf)

## Other formats

- [Markdown version](/-/media/files/publications/selected-issues-papers/2023/english/sipea2023005.pdf.md)
- [Structured JSON version](/-/media/files/publications/selected-issues-papers/2023/english/sipea2023005.pdf.json)

---

### Main purpose and approach
- Reviews the Magyar Nemzeti Bank’s (MNB) monetary operations since October 2013, assessing whether simpler and less activistic operations would be more effective in achieving the MNB’s primary objective of medium-term price stability.
- Analytical stance:
  - Takes an agnostic view between two perspectives:
    - Complex and frequent operations may be suitable if the central bank has superior information, transparent communication, and credibility.
    - Excess interventions may amplify noise, blur signals, and be counterproductive in the absence of credibility.
- Organization of analysis: phases of operations; objectives and instruments; changes to conventional and unconventional operations; transmission channels; lessons for future operations.

### Institutional context and mandates
- Primary objective: achieve and maintain price stability.
- Complementary objectives: preserve financial stability and support the government’s economic policy and environmental sustainability (unofficial English translation of the MNB Law, Art. 3).
- Decision body: Monetary Council (Art. 9(1) of the MNB Law) arbitrates trade-offs among potentially competing objectives.
- Key legal/institutional milestones:
  - Inflation-targeter since 2001.
  - Exchange rate free float since 2008.
  - Medium-term headline inflation target: 3 percent since 2005; inflation-tolerance band of 2–4 percent introduced in March 2015.
  - New central bank law effective October 2013 broadened MNB powers (including financial sector supervision and macroprudential policies); resolution powers framework in Act XXXVII in 2014.

### Main phases of Hungarian monetary operations since 2013
- Operations categorized into five broad phases, evident across inflation, credit growth, exchange rate, country-risk premia, and inflation expectations.

- Phase 1: 2013 to February 2016
  - Features: low inflation, monetary easing, re-leveraging the economy.
  - Actions and programs: Self-Financing Program (SFP); Funding for Growth Scheme (FGS); conversion of FX loans to local currency; gradual reduction of policy rates.
  - Inflation: decelerated and briefly negative; later increased but remained below tolerance band.

- Phase 2: March 2016 to February 2020
  - Features: inflation largely within tolerance band; moderate exchange rate depreciation; accommodative policy.
  - Operational target: absorption of excess liquidity; money market rates kept slightly positive.
  - Unconventional tools introduced to influence long end of yield curve (interest rate swaps), develop mortgage bond market (MNB purchases; new indices), and promote corporate bond market (Bond Funding for Growth Scheme, BGS).
  - Policy stance: maintained “loose” conditions; prepared for “gradual and cautious normalization” in September 2018; tools (i) and (ii) abolished by end-2018.
  - Outcome: credit growth to private sector strengthened; real interest rates remained negative.

- Phase 3: COVID pandemic (March 2020 to May 2021)
  - Features: market dysfunction; monetary and fiscal policies significantly eased.
  - Operational shift: toolkit overhauled; operational target shifted from excess liquidity to interest rates.
  - Actions: reduced policy rate but effectively tightened money market rates to support exchange rate; provided ample long-term liquidity; temporarily suspended penalization for breach of reserve requirements; enhanced FGS; introduced asset purchase program (APP) of government securities in secondary market; reactivated APP of mortgage bonds; eased APP of corporate bonds; temporarily relaxed various micro and macro-prudential rules.
  - Outcome: after initial depreciation, exchange rate stabilized; negative real interest rate remained relatively stable.

- Phase 4: Recovery (June 2021 to February 2022)
  - Features: stronger-than-expected recovery with accelerating inflation.
  - Drivers: external commodity prices and supply shortages; strong domestic demand fueled by expansionary fiscal policy up to April 2022 elections.
  - Response: refocused on fighting inflation by raising policy rates and phasing out unconventional tools (achieved by end-2021).

- Phase 5: Spillovers from Russia’s war in Ukraine (since February 2022)
  - Features: further monetary tightening; absorption of liquidity via longer-maturity instruments to counter depreciation pressures.
  - Drivers: increasing commodity prices, supply chain shortages, energy-supply concerns, strong domestic demand, widening imbalances, disputes with the EU increasing country risk premium.
  - Response highlights:
    - Turned real-interest rate (deflated by next-year inflation expectations) positive.
    - Enhanced liquidity-absorption tools: daily (instead of quarterly) FX swaps; higher reserve requirements; longer MNB deposits.
    - Temporary direct FX sales to importing energy companies.

### Competing goals, targets, and choice of instruments
- Theoretical framing:
  - Tinbergen (1952): one instrument per target is limited under stochastic disturbances and adjustment costs.
  - Brainard (1967) and Turnovsky (1977): conditions may favor multiple instruments.
  - Rule versus discretion: discretion can be optimal if the central bank is credible (Buiter, 1981); otherwise contingent rules may be preferable.
  - Simplicity benefits: facilitates communication and reduces credibility risk from micro-management.

- Practical tensions in MNB mandate:
  - Primacy of price stability to avoid resolving financial sector problems through ample liquidity that would generate inflation.
  - Financial-stability policies (e.g., encouraging longer interest-rate fixation) can impede monetary transmission.
  - Monetary Council and Financial Stability Council jointly decide tradeoffs.

- Interaction with government policy:
  - MNB is independent; cannot provide direct credit to government.
  - MNB interventions (e.g., government securities purchases) can ease government financing costs and appear quasi-fiscal.
  - Example: mid-2021 to May 2022—MNB tightened policy rates and phased out unconventional tools while remaining slower than peers to stop government securities purchases; with hindsight, a faster exit from government security purchases would likely have been beneficial though high uncertainty justified caution at the time.

- Sectoral and market interventions:
  - Interventions to boost intermediation in priority sectors (FGS, mortgage bond purchases) can be justified by perceived market failures but may distort funding costs and market segmentation; quasi-fiscal appearances better handled by state-owned development banks, public guarantee schemes, or fiscal instruments.

### Operational roles and division of labor
- Traditional roles:
  - Central bank anchors short end of yield curve, influences inflation expectations, and mitigates market dysfunction.
  - Government shapes risk along and within yield-curve segments.
- Institutional coordination: MNB Governor is a member of the Fiscal Council.
- Transparency and credible communication critical for market assessment of operations and implications.

### Key empirical observations and operational details
- MNB target and tolerance band: 3 percent target with 2–4 percent tolerance band since March 2015.
- Explicit chronology and dates:
  - Inflation-targeter since 2001.
  - Exchange rate free float since 2008.
  - New central bank law and broadened powers since October 2013.
  - Pandemic period: March 2020 to May 2021.
  - Recovery: June 2021 to February 2022.
  - Spillovers from Russia’s war in Ukraine: since February 2022.
- Specific operational changes:
  - Daily (instead of quarterly) FX swaps introduced post-February 2022 tightening.
  - Real-interest rate metric: deflated by next-year inflation expectations (used to assess stance turning positive).

### Complementarity and conflict between MNB and government policies
- Subsidized credit and guarantees
  - Subsidized bank lending (MNB’s FGS and government schemes) amounted to 31 percent of total bank credit to NFC as of end-September 2022.
  - For SMEs the share was 44 percent as of end-September 2022.
  - State-backed guarantees: 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.
  - Assessment: these initiatives alleviate credit risk and should thus have a more limited impact on the direct transmission of the MNB’s policy rates on corporate rates than subsidized lending.

- Housing and family-support policies vs macroprudential goals
  - At end-2021, about a quarter of newly issued housing loans were subsidized by the government.
  - Government measures (selected):
    - Housing benefit scheme introduced in 2016.
    - Rural housing scheme introduced in 2019.
    - Preferential VAT rate of 5 percent instead of 27 percent on sales of newly constructed residences during 2016–19 and 2022–27 for qualifying units.
    - Prenatal “baby” loans introduced mid-2019 and extended to end-2024: maximum loan of HUF 10 million (about €25,000) interest free if family has one child within five years; state assumes 30 percent of remaining debt in case of two children; government takes over whole remaining debt in case of three children.
    - Program to refurnish housing introduced in 2021 and extended in 2022.
  - MNB response: introduced and adjusted macroprudential policies for housing and promoted long-term mortgage bond market.
  - Assessment: many government schemes coincided with overheating construction sector and rapidly accelerating real estate prices, likely counteracting higher interest rates needed to cushion demand.

- MAP+ retail bond and market segmentation
  - MAP+ (introduced 2019): 5-year MAP+ simple average annual yield was 4.95 percent, compared to about 1.6 percent (average during 2019) of a 5-year benchmark government bond.
  - Since February 2022, 5-year benchmark yield has exceeded yield of MAP+.
  - MAP+ can be redeemed before 5-year maturity; after inflation increases households moved to inflation-indexed retail bonds or wholesale market.
  - Trade-off: segmentation can tap consumer surplus but raise a liquidity premium, affecting yield curve slope and monetary transmission.
  - Note: MAP+ and other retail bonds compete with retail bank deposits, but with a loan-to-deposit ratio well below 100 this never became a major issue.

- Debt-service moratoria
  - Hungary introduced a debt-service moratorium following the pandemic; it was extended several times and changed from opt-out to opt-in in November 2021.
  - Participation declined and expired at end-2022.
  - Moratorium for agricultural loans: September 2022 to end-2023.
  - Assessment: temporary moratoria ease repayment risks but extended measures after normalization can affect perceived risks, raise moral hazard, and artificially increase net interest margins.

- Climate-related measures
  - Government: supported energy insulation, stricter energy standards for new constructions since 2019 for public buildings and 2021 for other buildings, incentives for solar and wind.
  - MNB: green initiative reducing environmental risk costs of bank lending to green projects and support for green mortgages as part of APP.
  - Inconsistency noted: 2012/13 household utility subsidies likely delayed energy-saving investments; subsidy reduced for above-average consumption only in September 2022.
  - Assessment: policy inconsistencies can undermine overall effectiveness.

- Interest rate caps undermining transmission
  - Temporary 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 first half of 2022 at October 2021 level.
    - Cap later extended to end-June 2023 and broadened to mortgages with up to five years interest rate fixation.
    - Temporary interest cap on SME loans till end-June 2023.
  - 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, which currently is just below 12 percent.
    - Banks had been placing funds with the MNB at up to 18 percent (the current effective marginal policy rate).
    - Effect: measure promptly reduced yields on treasuries and thus indirectly on mortgage bonds, undermining monetary policy tightening.
  - Assessment: caps disconnect monetary transmission channels, may undermine financial stability via moral hazard and reduced bank profitability; targeted assistance to neediest borrowers would be more efficient and less distortive.

### Overview of monetary operations since 2013 and liquidity management
- Evolution:
  - Early: conventional tools for price stability; policy rates gradually reduced as inflation waned.
  - Middle: focus on liquidity management to keep money market rates close to floor of interest rate corridor; excess liquidity as intermediate target.
  - Pandemic: additional long-term liquidity via unconventional tools; liquidity overhang absorbed mainly by short-term instruments.
  - Since mid-2021: gradual tightening as recovery stronger than expected.
  - October 2022: tightened both price (policy rates) and quantity (longer liquidity-absorbing instruments) to make shortening the currency more expensive.

- Policy rates and indicators:
  - Base rate is mainly a signaling rate; effective policy rate determined by different instruments over time.
  - 3-month BUBOR rate considered “go-to” indicator to appraise impact on inflation and accounts better for expectations and structural liquidity changes.

- Liquidity management tools and pandemic actions:
  - Tools: long-term liquidity provision while absorbing excess liquidity via shorter instruments; preferential deposits with MNB; adjusting rates and collateral eligibility.
  - Pandemic-specific actions:
    - Increased liquidity-providing FX swaps.
    - Regular long-term collateralized loan tenders (maturities 3 months to 5 years at policy rate).
    - Broadened collateral eligibility by almost 5.5 percent of GDP to include performing corporate bank loans with a standard haircut of 30 percent.
    - Temporarily suspended penalties for deficient reserve requirements.
    - Introduced regular auctions of 1-week deposits to absorb excess liquidity.
    - Increased overnight overdraft rate and made interest corridor symmetrical around base rate to raise money market rates without initially changing base rate.
  - After Russia’s war in Ukraine: temporary easing then accelerated liquidity tightening since October 2022.

### Unconventional tools, balance sheet, and APPs
- MNB frequently used “unorthodox” instruments to incentivize credit institutions and strengthen transmission when impaired, typically sterilizing liquidity impact early in the period.
- MNB expanded unconventional tools after the pandemic, stressing clear communication, temporariness, and avoidance of fiscal dominance.
- Balance sheet: declined early in the analyzed period, stabilized, and grew rapidly during the pandemic.

- Asset Purchase Programs (APPs) — aggregate volumes and timing:
  - Pre-pandemic purchases: about 1.2 percent of GDP.
  - During the pandemic till end-2021 (when programs expired): additional 9.1 percent of GDP.
  - APP of government securities: about 6.4 percent of (2021) GDP.
  - Mortgage bond purchases in 2018: about 0.9 percent of GDP.
  - Corporate bond purchases in 2019: about 0.4 percent of GDP (not included in certain charts).
  - Government securities APP design:
    - Secondary-market purchases in longer maturities.
    - Initial per-issuance purchase limit 33 percent; increased to 50 percent; limit abolished March 2021.
    - Scope extended late summer 2020 to include government-guaranteed bonds (Exim, MFB).
    - Most government bonds (about 60 percent) bought at weekly tenders; rest bilateral trades.
    - MNB began reducing purchases from August 2021; program stopped December 2021.
  - Mortgage bond APP:
    - Initial program Dec 2017–Dec 2018; relaunched April 2020 with first purchases May 2020.
    - MNB intended to sterilize liquidity impact; by mid-November 2020 stated it would only buy green mortgage bonds in secondary market.
    - Pandemic purchases: about 0.6 percent of GDP.
  - Corporate bond APP — BGS:
    - Announced April 2019, launched July 2019, first purchases September 2019.
    - Eligibility: HUF-denominated bonds by Hungarian non-financial corporations with maturities 3–10 years (doubled to 20 years at pandemic start).
    - Credit risk limits: issuer rated at least B+; initial max exposure HUF 20 billion (about €61.5 million at the time), later HUF 50 billion (about €143 million).
    - MNB could buy up to 70 percent of an issuance in primary and secondary markets; later limited to up to 50 percent in secondary market.
    - Purchases from early May 2020 to end-April 2021: about 0.9 percent of GDP, of which almost 0.7 percent of GDP in the primary market.
    - BGS expired December 2021; few transactions finalized April 2022.

### Funding for Growth Scheme (FGS)
- Purpose: encourage inexpensive local-currency bank lending to credit-constrained SMEs and micro enterprises.
- Initial FGS announced April 2013: MNB provided zero interest funding to be on-lent against collateral at a maximum of 2.5 percent, maximum maturity 10 years, to facilitate FX loan conversion and reduce foreign funding.
- Liquidity absorption: participating banks could place excess liquidity with MNB at preferential rates, effectively subsidizing lending.
- Evidence and effects:
  - Endresz et al. (2015): FGS supported investments that would not otherwise have happened.
  - MNB (2017): FGS in 2013–2016 may have added about 2 percentage points to GDP and enhanced employment by around 20,000.
- Later developments: refinements; phased out as growth recovered and complemented by Market-Based Lending Scheme (MLS); reshaped during pandemic and retailored to support greening.
- Assessment: tailored support can be perceived as quasi-fiscal, especially when MNB accepted part of credit risk for a short period.
- Size: outstanding amount of various FGS loans amounted to about 4.2 percent of GDP at end-November 2022.

### Self-Financing Program (SFP): design and outcomes
- Objective: reduce external vulnerabilities of government debt.
- Duration: April 2014 to April 2016 (phased out thereafter).
- Design:
  - Made MNB liquidity-absorbing instruments less liquid relative to government securities (non-tradable, removed as eligible collateral, maturity increased from 2-week to 3-month; auction frequency and amounts reduced).
  - Eased day-to-day liquidity concerns via overdraft adjustments and offering interest rate swaps (IRS).
- Outcomes:
  - Banks increased government securities portfolio by almost 6 percentage points of GDP.
  - Contributed to decline in spread vis-à-vis German bunds (multiple factors at play).
  - Banks’ purchases of government securities exceeded AKK’s net forint issuance.
  - Lessened external vulnerabilities by helping reduce held public debt (by over €9 billion) and reducing share of FX-denominated debt (from about 50 to below 30 percent).
  - Contributed to a rating upgrade; Csávás and Kollarik (2016) found it lowered government financing costs.
  - Did not crowd out bank lending given ample liquidity and moderate private credit demand.
  - When reduction of MNB liquidity absorption matched banks’ purchases of government securities, liquidity impact was neutralized.
  - Facilitated maturity extension of banks’ bond portfolios and likely increased market liquidity.

### Transmission mechanism: evolving effectiveness and channels
- General: transmission evolves over time; impact of interest changes weaker after GFC.
- Interest rate channel:
  - Policy rate increases affected 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); rigidity of small depositors; competition for large depositors; interest rate caps and subsidy schemes.
  - Policy implication: operations may need to be tightened more than otherwise.

- Credit channel:
  - FGS, BGS and long-term collateralized lending facilities aimed at reinstating credit channel (MNB, 2019).
  - Loan-to-deposit rate history: 147 in October 2009; 113 in January 2013; 83 in September 2022.
  - Narrow credit-channel: influence supply of deposits and demand for loans.
  - Cost channel: higher cost of working capital in less competitive banking systems; risk premia issues after GFC mitigated by FGS and government schemes.
  - Broader credit-channel: importance of collateral; post-GFC dampening factor turned likely accelerating recently, contained by prudential regulation.
  - Bank lending to NFCs and households double-digit in recent years until global risks increased in 2022 and credit to households decelerated.

- Asset price channel:
  - Residential ownership about 91.3 percent in 2020 (EU-27 average 70.0 percent).
  - Only about half of residential real estate transactions financed by bank credit.
  - MNB housing model: an increase of the policy rate of about 465 bp would likely decrease housing prices by about 2 percentage points in Budapest area and 4 percentage points in rural areas.

- Exchange rate channel:
  - Depreciation typically boosts competitiveness but can initially hurt current account (J-curve).
  - Exchange rate pass-through to inflation is important for calibrating operations.

### Exchange rate pass-through and empirical findings for Hungary
- Pass-through characteristics:
  - Varies over time, non-linear, depends on depreciation vs appreciation and central bank credibility.
  - Empirical studies suggest exchange rate channel is strong in Hungary.

- Empirical findings:
  - 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, but declined to about 0.10 to 0.20 percent after the GFC.
  - Correlation analysis: depreciations correlated with higher inflation, particularly after 2–3 quarters; impact appears to have faded after the GFC.
  - Cross-country studies:
    - María-Dolores (2009): lower inflation and long-run exchange rate pass-through in inflation-targeting countries like Hungary.
    - Jašová et al. (2016): exchange rate pass-through declined in emerging markets, including Hungary, after the GFC.
    - Ortega and Osbat (2020): one percent depreciation typically resulted in headline inflation increasing on average by around 0.3 percent within a year; import prices somewhat higher impact (0.4–0.8 percent) for non-euro EU members.

### Conclusions and policy takeaways
- Compliance and evolution:
  - Many changes of monetary operations by MNB since 2013 have been within statutory mandate.
  - Preferences and binding constraints evolved; transmission channels developed accordingly.
  - Frequent modifications driven by concerns about market failures and changing transmission channels.
  - Introduction, adjustment, and revocation of tools generally clearly communicated and smoothly implemented.
  - Paper did not assess success of measures (requires counterfactual).

- General lessons:
  - Simplicity and transparency carry a premium. Temporary, correctly calibrated unconventional tools can help, but excessive modifications and an over-complex toolkit risk blurring monetary policy signals and harming credibility; clear and candid communication is critical.
  - The case for addressing market failures must weigh benefits of tailored interventions against risk of public sector failure; policymaking errors can durably affect credibility.
  - Prompt interventions to solve immediate challenges can have long-term consequences (example: ample long-term liquidity during pandemic created negative externalities visible during recovery; in addition to hiking rates in October 2022, lengthening maturity of liquidity-absorbing instruments was necessary).
  - MNB should continue to complement partial views with broader analysis and to point out positive and negative externalities of policy mix so markets can make informed decisions.

*Source: IMF staff summary of "Monetary Operations in Hungary Before, During, and After the Pandemic," Prepared by Tonny Lybek, January 17, 2023 (sipea2023005).*

### 1. Inflation and Monetary Policy Stance  ________________________________________________ 4

### sipea2023005 - 1. Inflation and Monetary Policy Stance

### Main purpose and approach
- Reviews the Magyar Nemzeti Bank’s (MNB) monetary operations since October 2013, assessing whether simpler and less activistic operations would be more effective in achieving the MNB’s primary objective of medium-term price stability.
- Takes an agnostic view between two perspectives:
  - Complex and frequent operations may be suitable if the central bank has superior information, transparent communication, and credibility.
  - Excess interventions may amplify noise, blur signals, and be counterproductive in the absence of credibility.
- Organizes the analysis across phases of operations, objectives and instruments, changes to conventional and unconventional operations, transmission channels, and lessons for future operations.

### Institutional context and mandates
- MNB primary objective: achieve and maintain price stability.
- Complementary objectives: preserve financial stability and support the government’s economic policy and environmental sustainability (as described in the unofficial English translation of the MNB Law, Art. 3).
- The Monetary Council (Art. 9(1) of the MNB Law) arbitrates trade-offs among potentially competing objectives.
- Legal and institutional notes:
  - MNB became an inflation-targeter in 2001.
  - Exchange rate free float since 2008.
  - Medium-term headline inflation target: 3 percent since 2005, with an inflation-tolerance band of 2–4 percent introduced in March 2015.
  - New central bank law effective October 2013 broadened MNB powers, including responsibility for financial sector supervision and macroprudential policies; the framework for resolution powers established in Act XXXVII in 2014.

### Main phases of Hungarian monetary operations since 2013
- Monetary operations since 2013 can be categorized into five broad phases; these are evident when gauging inflation, credit growth, exchange rate, country-risk premia, and inflation expectations.

- Phase 1: 2013 to February 2016
  - Characterized by low inflation, monetary easing, and efforts to reduce vulnerabilities and re-leverage the economy.
  - Inflation decelerated and briefly became negative; later increased but remained below the tolerance band.
  - Policy actions and programs:
    - Self-Financing Program to reduce external government vulnerabilities.
    - Funding for Growth Scheme (FGS) to mitigate SME credit crunch.
    - Conversion of FX loans to local currency to reduce household vulnerabilities.
    - Gradual reduction of policy rates.

- Phase 2: March 2016 to February 2020
  - Inflation largely within the tolerance band, moderate exchange rate depreciation, accommodative monetary policy.
  - Operational target: absorption of excess liquidity; money market rates kept slightly positive.
  - Unconventional tools introduced to:
    - Influence the long end of the yield curve (interest rate swaps).
    - Develop the mortgage bond market (MNB purchases of mortgage bonds; new mortgage-bond indices).
    - Promote corporate bond market via Bond Funding for Growth Scheme (BGS).
  - MNB maintained “loose” conditions but prepared for “gradual and cautious normalization” in September 2018; tools (i) and (ii) abolished by end-2018.
  - Credit growth to the private sector strengthened; real interest rates remained negative.

- Phase 3: COVID pandemic (March 2020 to May 2021)
  - Initially lowered inflation but caused market dysfunction.
  - Monetary and fiscal policies significantly eased.
  - MNB overhauled toolkit and shifted operational target from excess liquidity to interest rates.
  - Actions included:
    - Reduced policy rate but effectively tightened money market rates to support the exchange rate.
    - Provided ample long-term liquidity.
    - Temporarily suspended penalization for breach of reserve requirements.
    - Enhanced FGS.
    - Introduced asset purchase program (APP) of government securities in the secondary market.
    - Reactivated APP of mortgage bonds and eased conditions of APP of corporate bonds.
    - Temporarily relaxed various micro and macro-prudential rules.
  - After initial depreciation, exchange rate stabilized; negative real interest rate remained relatively stable.

- Phase 4: Recovery (June 2021 to February 2022)
  - Stronger than expected recovery with accelerating inflation.
  - Drivers: external factors (commodity prices, supply chain shortages) and strong domestic demand fueled by expansionary fiscal policy up to April 2022 elections.
  - MNB response: refocused on fighting inflation by raising policy rates and phasing out unconventional tools (achieved by end-2021).

- Phase 5: Spillovers from Russia’s war in Ukraine (since February 2022)
  - Necessitated further monetary tightening, including absorption of liquidity via longer-maturity instruments to counter depreciation pressures.
  - Drivers: increasing commodity prices, supply chain shortages, energy-supply concerns, still strong domestic demand, widening imbalances, disputes with the EU increasing country risk premium.
  - Response included:
    - Turning the real-interest rate (deflated by next-year inflation expectations) positive.
    - Enhancing liquidity-absorption tools through daily (instead of quarterly) FX swaps, higher reserve requirements, and longer MNB deposits.
    - Temporary direct FX sales to importing energy companies.

### Competing goals, targets, and the choice of instruments
- Theoretical framing:
  - Tinbergen (1952) concept (one instrument per target) is limited when stochastic disturbances and adjustment costs exist; a combination of instruments can be optimal.
  - Brainard (1967) and Turnovsky (1977) show circumstances favoring multiple instruments.
  - Rule versus discretion: Buiter (1981) highlights discretion can be optimal if the central bank is credible; otherwise contingent rules may be preferable.
  - Simplicity benefits: plainness facilitates communication and reduces credibility risk from micro-management.

- Practical tensions within the MNB mandate:
  - Delegation of primacy to price stability aims to prevent resolving financial sector problems merely by providing ample liquidity (which would generate inflation).
  - Policies to enhance financial stability can impede monetary transmission (e.g., encouraging longer interest rate fixation reduces vulnerability but impedes transmission).
  - Monetary Council and Financial Stability Council jointly decide on these tradeoffs.

- Interaction with government policy:
  - MNB is independent and cannot provide direct credit to the government.
  - The MNB can still influence funding costs and the yield curve; some interventions (e.g., government securities purchases) may ease government financing costs and risk appearing quasi-fiscal.
  - Example: mid-2021 to May 2022—MNB tightened policy rates and phased out unconventional tools while remaining slower than peers to stop government securities purchases; with hindsight, the MNB considers a faster exit from government security purchases would likely have been beneficial, though high uncertainty justified caution at the time.

- Sectoral and market interventions:
  - MNB interventions to boost intermediation in priority sectors (FGS, mortgage bond purchases) are justified by perceived market failures but can distort funding costs and market segmentation, creating quasi-fiscal appearances better handled by state-owned development banks, public guarantee schemes, or fiscal instruments.

### Operational roles and division of labor
- Traditional division of labor:
  - Central bank anchors short end of the yield curve, influences inflation expectations, and mitigates market dysfunction.
  - Government shapes risk along and within yield-curve segments.
- Institutional coordination example: MNB Governor is a member of the Fiscal Council.
- Transparency and credible communication are critical for market assessment of operations and their implications.

### Key empirical observations (as presented)
- MNB’s target and tolerance band: 3 percent target with 2–4 percent tolerance band since March 2015.
- Chronology and dates explicitly cited:
  - Inflation-targeter since 2001.
  - Exchange rate free float since 2008.
  - New central bank law and broadened powers since October 2013.
  - Pandemic period: March 2020 to May 2021.
  - Recovery: June 2021 to February 2022.
  - Spillovers from Russia’s war in Ukraine: since February 2022.
- Specific operational changes:
  - Daily (instead of quarterly) FX swaps introduced during the post-February 2022 tightening.
  - Real-interest rate metric: deflated by next-year inflation expectations (used to assess stance turning positive).

*Source: IMF staff summary of "Monetary Operations in Hungary Before, During, and After the Pandemic," Prepared by Tonny Lybek, January 17, 2023.*

### 12.      Over the years, MNB and government policies have occasionally been complementary

### 12.      Over the years, MNB and government policies have occasionally been complementary or conflicted

### Subsidized credit and guarantees
- Subsidized bank lending (the MNB’s FGS and various government schemes) amounted to 31 percent of total bank credit to NFC as of end-September 2022.
- For SMEs the share was 44 percent as of end-September 2022.
- The government’s Széchenyi Program began in 2002 and has seen several versions, including during the pandemic; Széchenyi Card Max was introduced in September 2022.
- The state-owned Hungarian Development Bank (MFB) and Exim Bank offer various programs, enhanced during the pandemic.
- 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.
- Assessment: these initiatives alleviate credit risk and should thus have a more limited impact on the direct transmission of the MNB’s policy rates on corporate rates than subsidized lending.

### Housing and family-support policies vs macroprudential goals
- At end-2021, about a quarter of newly issued housing loans were subsidized by the government.
- Government measures included:
  - A housing benefit scheme introduced in 2016 (grant and subsidized interest rates; conditions adjusted over time).
  - A rural housing scheme introduced in 2019.
  - A preferential VAT rate of 5 percent instead of 27 percent on 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; the state will assume 30 percent of the remaining debt in case of two children; the government will take over the whole remaining debt in case of three children.
  - A program to refurnish housing was introduced in 2021 and extended in 2022.
- MNB actions: introduced and gradually adjusted macroprudential policies for housing and promoted the market for long-term mortgage bonds.
- Assessment: many government schemes coincided with an overheating construction sector and rapidly accelerating real estate prices, likely counteracting higher interest rates needed to cushion demand.

### Segmentation of government securities market and MAP+ retail bond
- In 2019 a special retail bond, MAP+, was introduced; initially it offered above-market yields.
- 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+ bonds can be redeemed before their 5-year maturity; after inflation increases many households moved to inflation-indexed retail bonds or the wholesale market.
- Trade-off: market segmentation can “tap” consumer surplus but may raise a “liquidity premium” due to smaller issuance per type, affecting the slope and bumpiness of the yield curve and monetary transmission.
- Note: MAP+ and other retail bonds compete with retail bank deposits, but with a loan-to-deposit ratio well below 100 this never became a major issue.

### Debt-service moratoria and extensions
- Hungary introduced a debt-service moratorium following the pandemic; unlike peers it was extended several times and changed from opt-out to opt-in in November 2021.
- Participation declined and expired at end-2022.
- Government announced a moratorium for agricultural loans from September 2022 to end-2023 due to rising energy and fertilizer prices and a drought.
- Assessment: temporary moratoria ease repayment risks but extended measures after normalization can affect perceived risks, raise moral hazard, and artificially increase net interest margins.

### Climate-related measures: complementarities and inconsistencies
- Government measures: supported energy insulation, required stricter energy standards for new constructions since 2019 for public buildings and 2021 for other buildings, and provided incentives for solar and wind electricity production.
- MNB measures: green initiative including reducing environmental risk costs of bank lending to green projects and support for green mortgages as part of its APP.
- Inconsistency: in 2012/13 the government introduced significant subsidies of household utilities which likely delayed investments in energy savings; only in September 2022 was the utility subsidy reduced for above average consumption.
- Assessment: partial vs general policy analysis inconsistencies can undermine overall policy effectiveness.

### Interest rate caps undermining transmission (recent)
- Temporary 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 broadened to mortgages with up to five years interest rate fixation periods.
  - Temporary interest cap on SME loans till end-June 2023.
- Assessment: caps disconnect key channels of monetary policy transmission, may undermine financial stability via moral hazard and reduced bank profitability; targeted assistance to the neediest borrowers would be more efficient and less distortive.
- 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, which currently is just below 12 percent.
  - Banks had been placing funds with the MNB at up to 18 percent (the current effective marginal policy rate).
  - Effect: measure promptly reduced yields on treasuries and thus indirectly on mortgage bonds, undermining monetary policy tightening.

### Overview of Hungarian monetary operations since 2013
- Evolution:
  - Early period: conventional tools for price stability; policy rates gradually reduced as inflation waned.
  - Middle period: focus on liquidity management to keep money market rates close to the floor of the interest rate corridor; pushed liquidity into the system with excess liquidity as intermediate target.
  - Pandemic: additional long-term liquidity provided via unconventional tools; liquidity overhang absorbed mainly by short-term instruments.
  - Since mid-2021: gradual tightening as recovery stronger than expected.
  - October 2022: tightened both price (policy rates) and quantity (longer liquidity-absorbing instruments) to make shortening the currency more expensive.
- Policy rates and indicators:
  - The base rate is mainly a signaling rate; effective policy rate has been determined by different instruments over time.
  - The 3-month BUBOR rate is considered the “go-to” indicator to appraise the impact on inflation of interest rate changes and better accounts for expectations and structural liquidity changes.

### Liquidity management actions and patterns
- Tools used to absorb and provide liquidity and to influence behavior included:
  - Providing long-term liquidity while absorbing excess liquidity via shorter instruments.
  - Preferential deposits with the MNB to incentivize behaviors.
  - Adjusting rates and eligibility of collateral for standing and emergency facilities.
- During the pandemic the MNB:
  - Increased liquidity-providing FX swaps.
  - Introduced regular long-term collateralized loan tenders (maturities from 3 months to 5 years at the policy rate).
  - Broadened collateral eligibility by almost 5.5 percent of GDP to include performing corporate bank loans with a standard haircut of 30 percent.
  - Temporarily suspended penalties for deficient reserve requirements.
  - To absorb excess liquidity, introduced regular auctions of 1-week deposits.
  - Increased the overnight overdraft rate and made the interest corridor symmetrical around the base rate to raise money market rates without initially changing the base rate.
- After Russia’s war in Ukraine: temporary easing in response to heightened uncertainty, then accelerated liquidity tightening since October 2022.

### Unconventional monetary tools and MNB balance sheet dynamics
- The MNB frequently used “unorthodox” instruments to incentivize credit institutions and strengthen transmission when impaired, typically sterilizing liquidity impact early in the period.
- The MNB expanded unconventional tools after the pandemic, drawing on advanced-economy experiences that stress clear communication, temporariness, and avoidance of fiscal dominance.
- The MNB balance sheet declined early in the analyzed period, stabilized, and grew rapidly during the pandemic.

### Funding for Growth Scheme (FGS)
- FGS purpose: encourage inexpensive local-currency bank lending to credit-constrained SMEs and micro enterprises.
- Initial FGS announced in April 2013: MNB provided zero interest funding to be on-lent against collateral at a maximum of 2.5 percent, with maximum maturity of 10 years, to facilitate FX loan conversion and reduce foreign funding.
- Liquidity was absorbed by allowing participating banks to place excess liquidity with the MNB at preferential rates, effectively subsidizing lending.
- Evidence and effects:
  - Endresz et al. (2015) found FGS supported investments that would not otherwise have happened.
  - The MNB (2017) notes FGS in 2013–2016 may have added about 2 percentage points to GDP and enhanced employment by around 20,000.
- Later developments:
  - Several refinements made; as growth recovered the 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 greening of the economy.
  - Assessment: tailored support can be perceived as quasi-fiscal, especially when MNB accepted part of credit risk for a short period.
- Size: outstanding amount of various FGS loans amounted to about 4.2 percent of GDP at end-November 2022.

*Source: sipea2023005 — IMF selected issues paper (PDF).*

### 21.      The Self-Financing Program (SFP) incentivized banks to move their excess liquidity

### 21.      The Self-Financing Program (SFP) incentivized banks to move their excess liquidity

### Self-Financing Program (SFP): objectives, design, and outcomes
- Objective:
  - Reduce external vulnerabilities of government debt.
- Duration:
  - It lasted from April 2014 to April 2016, whereupon it was phased out.
- Design elements:
  - Banks were encouraged by making the MNB liquidity absorbing instruments less liquid compared to government securities.
  - The main liquidity absorbing instrument became gradually less liquid: it was no longer tradable and removed as eligible collateral for MNB facilities; its maturity increased from 2-week to 3-month; auction frequency and amounts were gradually reduced.
  - Concerns about day-to-day liquidity management and market turbulence were eased by adjusting the overdraft facilities and offering interest rate swaps (IRS).
- Key outcomes and findings:
  - Banks increased their portfolio of government securities by almost 6 percentage points of GDP.
  - It coincided with a declining the spread vis-à-vis German bunds, although a range of factors were likely at play.
  - Banks’ purchases of government securities exceeded the AKK’s net forint issuance (Bodnár et al., 2016, page 38).
  - It lessened external vulnerabilities by:
    - helping reduce the held public debt (by over €9 billion),
    - reducing the share of FX denominated debt (from about 50 to below 30 percent).
  - It contributed to a rating upgrade.
  - Csávás and Kollarik (2016) found that it lowered the financing costs of the government.
  - Given the ample liquidity in the banking system and moderate private credit demand, it did not crowd-out bank lending.
  - To the extent the reduction of MNB liquidity absorption matched banks’ purchases of government securities, the liquidity impact was neutralized.
  - It facilitated a maturity extension of banks’ bond portfolios and likely made this market more liquid.

### Asset Purchase Programs (APPs): scope, timing, and aggregate volumes
- Overview and objectives:
  - The MNB introduced asset purchase programs (APPs) for mortgages in 2018, corporate bonds in 2019, and government securities in 2020.
  - Initial purpose: spur development of mortgage and corporate bond markets.
  - During the pandemic, APPs were an important component of COVID-crisis measures to alleviate market dysfunction, ensure adequate liquidity support, mitigate liquidity hoarding and shorter investments, and later to ease government funding costs.
  - With hindsight, continuation of the APPs after mid-2021 appear not to have been consistent with the MNB’s rate increases as inflation was taking off.
- Aggregate purchase volumes:
  - Before the pandemic, the MNB had purchased securities for about 1.2 percent of GDP.
  - During the pandemic till end-2021, when these programs expired, the MNB bought bonds for an additional 9.1 percent of GDP.
  - The APP of government securities: MNB bought government bonds for about 6.4 percent of (2021) GDP.
  - The MNB’s purchases of mortgage bonds during 2018 amounted to about 0.9 percent of GDP.
  - The MNB’s purchases of corporate bonds in 2019 (before the pandemic) amounted to about 0.4 percent of GDP (not included in certain charts).
- Government securities APP (design and implementation):
  - Purchases were conducted only in the secondary market, and in longer maturities.
  - Initial per-issuance purchase limit: 33 percent; later increased to 50 percent; limit abolished in March 2021.
  - Scope extended in late summer 2020 to include government guaranteed bonds (Exim Bank and Hungarian Development Bank).
  - Most government bonds (about 60 percent) were bought at the weekly tenders, while the rest as bilateral trades.
  - The program envelope was gradually increased; MNB began to announce targeted amounts and gradually reduced its purchases starting August 2021 until the program stopped in December 2021.
  - The MNB purchased a substantial part of new net issuances and was concerned that a rapid exit could trigger market volatility.
  - At that time the MNB had not expressed any intention to sell these bonds as part of quantitative tightening.
- Mortgage bond APP:
  - Initial program active from December 2017 to December 2018.
  - Relaunched in April 2020 with first purchases in May 2020.
  - MNB announced it intended to sterilize the liquidity impact; in mid-November 2020 MNB stated it would only buy greenmortgage bonds in the secondary market.
  - During the pandemic, the MNB purchased mortgage bonds for about 0.6 percent of GDP.
- Corporate bond APP — Bond Funding for Growth Scheme (BGS):
  - Announced April 2019, launched July 2019, first purchases in September 2019.
  - Eligible: HUF denominated bonds issued by Hungarian non-financial corporations with maturities 3 to 10 years (doubled to 20 years at start of pandemic).
  - Credit limits and risk management:
    - Issuer should be rated at least B+.
    - Maximum exposure initially limited to HUF 20 billion (about €61.5 million at the time), later increased to HUF 50 billion (about €143 million).
    - MNB could buy up to 70 percent of an issuance in the primary and secondary markets, later limited to up to 50 percent in the secondary market.
    - Most issuances were rated by Scope Rating.
  - Purchases and timing:
    - From early May 2020 to end-April 2021, the MNB bought corporate bonds for about 0.9 percent of GDP, of which almost 0.7 percent of GDP in the primary market.
    - The BGS expired in December 2021, with a few transactions finalized in April 2022.

### Transmission mechanism: evolving effectiveness and channels
- General observation:
  - Transmission changes over time; tighter monetary policy tends to contract output and contain inflation (when driven by demand), and vice versa.
  - The impact of an interest change seems to have become markedly weaker after the GFC.
- Interest rate channel:
  - Recent policy rate increases 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).
    - Rigidity of small depositors; competition for large depositors has intensified.
    - Interest rate caps and subsidy schemes will further impede the interest channel.
  - Policy implication: Monetary operations may need to be tightened even further than otherwise.
- Credit channel (narrow and broader; cost channel):
  - FGS, BGS and long-term collateralized lending facilities aimed at reinstating the credit channel (MNB, 2019).
  - Narrow credit-channel:
    - Focused on influencing supply of deposits and demand for loans.
    - Loan-to-deposit rate history: 147 in October 2009; 113 in January 2013; 83 in September 2022.
  - Cost channel:
    - Cost of working capital can be higher in less competitive banking systems and for newly established SMEs without relationship banking.
    - Risk premia were an issue after the GFC; FGS and government subsidized credit and guarantee schemes, combined with strong recovery, mitigated this factor.
  - Broader credit-channel:
    - Importance of collateral to further lending (financial accelerator).
    - Right after the GFC it was a dampening factor; recently likely an accelerating factor, although contained by prudential regulation.
    - Bank lending (transactions) to both NFCs and households were double-digit in recent years until global risks increased in 2022 and credit to households decelerated.
- Asset price channel:
  - Real estate is the most important household asset in Hungary: residential ownership about 91.3 percent in 2020 (EU-27 average 70.0 percent).
  - Hungarian mortgages often constitute the largest household debt and, given long maturities, have profound persistent impacts on savings and consumption decisions.
  - Currently only about half of residential real estate transactions in Hungary are financed by bank credit.
  - MNB housing model result: 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.
- Exchange rate channel:
  - Exchange rate depreciation typically makes exports more competitive and imports more expensive; it thus boosts domestic activity but can initially hurt the current account due to J-curve effects.
  - As activity accelerates and import prices increase, inflation will increase, particularly if capacity constraints are breached.

*Source: sipea2023005 (IMF Selected Issues Paper).*

### 34.      A clear understanding of

### 34.      A clear understanding of 

### Exchange rate pass-through and monetary calibration
- "A clear understanding of the pass-through of exchange rate changes to inflation is essential for calibrating monetary operations to achieve price stability."
- The pass-through:
  - "varies over time, is non-linear, depends on whether a depreciation or an appreciation, and the credibility of the central bank (Ha at al., 2019)."
  - "Empirical studies suggest that the exchange rate channel is strong in Hungary."

### Empirical findings for Hungary
- Vonnák (2005) found that:
  - "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) found that:
  - "a depreciation of one percent let to an increase of inflation by about 0.30 percent after two years,"
  - "but that it declined to about 0.10 to 0.20 percent after the GFC."
- Additional empirical notes:
  - "A simple analysis of correlations coefficients confirms that depreciations are correlated with higher inflation, particularly after 2-3 quarters, but also that the impact appears to have faded after the GFC."
  - Regional and cross-country studies referenced:
    - María-Dolores (2009) noted "lower inflation and long-run exchange rate pass-through in inflation-targeting countries, like Hungary."
    - Jašová et al. (2016) found "that the exchange rate pass-through had declined in emerging markets, including Hungary, after the GFC, which was likely associated with generally declining inflation."
    - Ortega and Osbat (2020) found "one percent depreciation typically resulted in headline inflation increasing on average by around 0.3 percent within a year; while somewhat higher impact on import prices (0.4–0.8 percent) for non-euro EU members."

### Conclusion and takeaways on monetary operations (paragraph 35)
- Overall assessment:
  - "The many changes of monetary operations by the MNB since 2013 have been within its statutory mandate."
  - "Preferences and binding constraints have evolved over time. The transmission channels have developed accordingly."
  - "The frequent modifications of monetary operations have been driven by concerns about market failures and changing transmission channels."
  - "The introduction, adjustment, and revocation of monetary tools, when they no longer served their purpose, have been clearly communicated and generally smoothly implemented."
  - "The paper did not intend to assess the success of the measures, which is only possible with a counterfactual."
- General lessons drawn:
  - "Simplicity and transparency come with a premium. Temporary correctly calibrated unconventional tools can be helpful, but excessive modifications and over-complex set of tools risk blurring the signaling of monetary policy and, ultimately, negatively impacting central bank credibility. Thus, clear and candid communication is critical for credible monetary operations. Then there is less need for complicated explanations, which are more likely to be misunderstood, and result in blurred signals."
  - "The case for addressing market failure needs to be weighed carefully. The benefits of tailored and frequent interventions to address perceived market failures, should be carefully weighed against the risk of public sector failure. ... policymaking is not immune to mistakes that can durably affect the credibility of monetary operations. This demands consideration in the case for and design of new tools but should not be an excuse for not acting when monetary operations have a comparative advantage to other policies."
  - "Prompt intervention to solve immediate challenges can have long-term consequences that should be considered at the time. A case in point is the ample provision of long-term liquidity during the pandemic. Well-intended at the time, it entailed negative externalities that became visible during the recovery. In addition to hiking rates in October 2022, it also became necessary to lengthen the maturity of liquidity-absorbing instruments to make it more costly to speculate against the currency. Perhaps earlier tighter liquidity management (together with actions that would have helped reduce the risk premium) would have contained the pressures at an earlier stage?"
  - "Continue to complement partial views with more general analysis. The MNB is independent and provides comprehensive explanations of its monetary operations. Occasionally, the MNB and government operations reinforce one another—for instance, the MNB’s Self-Financing Program—or are contradictory—such as the government’s recent temporary interest rate caps, which clearly impedes monetary policy transmission. ... The MNB should continue to point to the positive and negative externalities of the policy mix, as it has recently done in its various publications, so that the market can make informed decisions."

*Source: sipea2023005 - 34.      A clear understanding of (PDF chapter) — International Monetary Fund*

---


_Source: https://www.imf.org/-/media/files/publications/selected-issues-papers/2023/english/sipea2023005.pdf_