## _wp0872

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---

### Introduction and purpose
- Purpose: analyze monetary policy challenges in the Czech Republic amid rising inflation pressures, a fiscal reform package, and a planned reduction in the inflation target from 3 percent to 2 percent effective January 2010.
- Model used: IMF’s Global Integrated Monetary and Fiscal Model (GIMF) by Kumhof and Laxton (2007a,b), a two-country, quarterly, non-Ricardian general equilibrium model where “home” = Czech Republic and “rest of the world” = euro area.
- Paper structure (as presented): Section II reviews the environment for the CNB; Section III describes GIMF; Section IV assesses monetary implications of the fiscal reform package; Section V examines remaining macroeconomic challenges; Section VI explores implications of reducing the inflation target from 2010; Section VII concludes.

### Environment and challenges for monetary policymaking
- Inflation and demand
  - Core inflation was around 1 percent for most of 2006 but reached over 5 percent at end-2007.
  - The output gap is estimated to have turned positive in 2006 and increased steadily during 2007.
- Wages and labor market
  - Real wage growth reached 6 percent in the first quarter of 2007.
  - Unemployment rate reached a record low below 6 percent.
  - Immigration increased since early 2005; foreign workers composition: Slovaks 47 percent, Ukrainians 25 percent, Poles 10 percent.
  - Labor shortages emerging in skilled jobs (IT, automotive) and construction; skill mismatches and lower youth labor participation contribute.
- Exchange rate and interest rates
  - Koruna depreciation/appreciation movements in 2007: depreciated by 4 percent against the euro in the first half of 2007; later, koruna appreciated by about 5 percent against the euro in about two months toward end-2007.
  - Carry trade dynamics driven by ECB tightening and relatively low Czech interest rates contributed to volatility.
- Fiscal reform package (approved last August)
  - Introduction of a 15 percent flat tax rate on personal income (PIT). (Envisaged reduction to 12.5 percent in 2009 is uncertain and not considered.)
  - Increase of the lower VAT rate from 5 to 9 percent in 2008.
  - Phased reduction in corporate income tax (CIT) from 24 to 19 percent by 2010.
  - Cut in social spending by about 0.7 percent of GDP in 2008-10.
  - Increases in excises (not modeled in the analysis).
- Inflation target change
  - CNB announced in March 2007 lowering annual CPI inflation target from 3 to 2 percent effective January 2010.
  - CNB intends inflation to descend gradually to the new target well before 2010 but has not provided a benchmark path.
- Euro adoption and ERM II
  - Earliest feasible euro adoption date moved from 2010 to 2012; joining ERM II would be required in 2010 under the updated strategy.
  - Tradeoff between exchange rate and price stability in ERM II means major indirect tax hikes complicate the CNB’s task.
  - Looming long-term spending pressures from population aging and delays in fiscal consolidation could threaten the price stability criterion via additional demand pressures.

### Brief description of GIMF and calibration
- Model features
  - Multi-country, non-Ricardian, large-scale open-economy model with optimizing consumers and producers, sticky prices, real and nominal rigidities, monopolistic competition.
  - Agents are forward-looking but non-Ricardian; fiscal policy is countercyclical; monetary policy follows an inflation-targeting reaction function.
- Calibration and fiscal sector
  - Steady state GDP ratios and macro variables derived from national accounts averaged over 1995-2005/6.
  - Structural parameters adapted from literature on Czech Republic, Western Europe, United States, or Chile when Czech estimates unavailable.
  - Government collects taxes on consumption, labor, capital, and lump-sum taxes; spends on public consumption, public investment, and transfers.
  - Fiscal parameters set exogenously during the period to allow automatic stabilizers; long-term stability enforced through a government-set budget balance target.
- Monetary policy rule and parameters
  - CNB targets inflation rate of 3 percent in baseline.
  - Sacrifice ratio: around 1.5 (compared with 1.1 in earlier GEM calibrations and 2.1 for the euro area).
  - Monetary policy rule parameters:
    - interest rate smoothing coefficient iμ = 0.75
    - response to inflation forecast gap πμ = 1.4
    - response to output growth gdpmu = 0.4 (output growth used instead of output gap)
  - Euro area parameters used: igdpπ μμμ === 0.5;2;0.5

### Fiscal package: assumptions and first-round effects
- Implementation timing and expectations
  - Assume implementation starts in 2008Q1; because already announced, agents begin adjusting behavior and expectations as early as 2007.
- Assumed tax and transfer effects on effective rates
  - Increase in lower VAT rate from 5 to 9 percent (a 4 percentage point hike) assumed to raise the effective VAT tax rate by 1.1 percentage point (because these goods weigh 28 percent in the consumption basket).
  - Introduction of the flat PIT assumed to decrease the effective PIT rate by 1.1 percentage point.
  - Gradual CIT reform assumed to generate a decline in the tax rate by 1.2 percentage points in 2008 and by an additional 0.4 percentage point in 2009 and 2010.
  - Social transfers to households assumed cut by 0.6, 0.7, and 0.8 percentage point of pre-shock GDP in 2008, 2009, and 2010 respectively.
  - For the exercise, tax rates are assumed not to change after the reform and benefit cuts are permanent.
- Headline inflation first-round effects
  - First-round effects of the VAT hike could push headline inflation by about 1 percentage point.
  - In the baseline assumption, no special retailer margin behavior is assumed, so headline inflation is impacted one-to-one by the increase in the lower VAT rate.
  - First-round direct price effect could be spread over a more protracted period if retailers squeeze margins or mitigated by low-cost/high-efficiency international retailers ("Wal-Mart Effect").
  - Note: first-round effects are included in headline inflation shown in the graphs but are not included in the inflation indicator taken into account by monetary policy.

### Fiscal package: supply-side and demand-side impacts (model results summary)
- Supply-side effects and real sector
  - Tax cuts boost supply:
    - Investment increase of up to 5 percent over the next three years (due to the CIT cut).
    - Increase in labor supply from the PIT cut.
  - PIT cuts increase households’ take-home pay and moderate gross wage demands by unions.
  - VAT hike and reduction in social expenditures dampen household demand.
- Macroeconomic summary statistics
  - Fiscal balance would improve by ½ percentage point of GDP over the whole period.
  - The reduction in social expenditures would more than compensate for the loss in tax revenues.
  - Annual growth could be spurred by over ¼ percentage point in 2009-10.
  - Combination of negative consumption demand shock and positive supply shock leads to a ½ percentage koruna depreciation, boosting net exports.
  - Overall expansionary impact: the fiscal package is moderately expansionary but falls short of significant fiscal consolidation.
- Quantitative headline from model (policy-relevant inflation and interest rates)
  - Monetary-policy-relevant inflation (excluding first-round indirect tax effects) is estimated to decrease by about 0.5 percentage point over the next two to three years and will allow a fall in nominal interest rate, estimated at 40 basis points in GIMF.

### Combined shocks: inflation and monetary-policy implications
- Combined non-fiscal shocks examined in addition to the fiscal package
  - Positive output gap of about ½ percent (from a temporary boost in consumption).
  - Wage increase of about 1½ percentage points (from current labor shortages).
  - Koruna depreciation of 2 percent in 2008 (consistent with 2007 carry trade movements).
- Inflationary pressures in 2008 (breakdown)
  - Overall inflation could be boosted by as much as 2½ percentage points above the target during 2008.
    - 1 percentage point derives directly from the VAT hike (first-round effect).
    - Koruna depreciation would generate close to ¾ percentage point additional inflation.
    - The positive output gap contributes ½ percentage point in 2008.
    - Wage increases contribute ½ percentage point in 2008.
- Monetary policy reaction magnitudes
  - Reaction to each of the non-VAT shocks would range from 100 to 150 basis points in 2008.
  - Overall nominal interest-rate hike could be as much as 250 basis points.
  - Peak rise in real interest rate of close to 100 basis points.
- Outcome of tightening
  - Sharp tightening would curb inflation over 2009-10 with a return to target in 2011, but at the cost of a substantial cyclical reversal and higher real rates.

### Real economy and cycle dynamics under monetary tightening
- Effects through 2010
  - Temporary boost in consumption and wages would abate.
  - Delayed effects of monetary tightening throughout 2010 push the output gap into negative territory by the end of the decade.
  - Wage shock reduces corporate profitability and is particularly detrimental to activity.
  - Real appreciation of the exchange rate and loss in competitiveness would further dampen growth.
  - Following the correction, downward wage adjustments would further reduce consumption.

### Effects of reducing the inflation target to 2 percent (CNB decision): scenarios and implications
- Policy background
  - CNB announced lowering the target from 3 to 2 percent from January 2010 onwards.
- Scenario A — Unexpected (not fully anticipated by households)
  - Model suggests stickiness may require an increase in the nominal interest rate of 75 basis points on top of earlier hikes.
  - Real interest rates would rise sharply, deteriorating the output gap by some 1½ percentage points.
  - Investment would be further hit; real exchange rate appreciation from lower domestic inflation would weigh on exports.
- Scenario B — Expected (fully anticipated and incorporated by the public in advance)
  - Real effects would be negligible.
  - No action required from monetary policy authorities.
  - Inflation would start adjusting downwards as early as 2009.
  - Critical importance of CNB communication to achieve this outcome.

### Conclusions and policy recommendations
- Fiscal package by itself does not put pressure on monetary-policy-relevant inflation (excluding first-round VAT effects) but does not ease monetary policy’s task in cooling other shocks.
- Risks remain that the fiscal package could add price pressure in the context of resource constraints and a tightening labor market.
- A further reduction in the fiscal deficit would ease the burden on monetary policy in keeping inflation within target amid demand-driven pressures.
- If the 2010 lower inflation target is not fully incorporated in public behavior, monetary policy may have to tighten again, imposing short-run costs on the real economy.
- Strengthening the CNB’s communication strategy is essential to avoid short-run negative real effects and to anchor expectations to the new target.
- Fiscal policy should play a greater supportive role to monetary policy on the route to euro adoption, since nominal convergence will make it harder to fulfill the price stability criterion by monetary policy alone.

### Appendix figures: coverage and notes (2007Q1–2015Q1)
- Source for figures and shocks: IMF staff estimates.
- Recurrent note: "First round effects are included in the headline inflation. However, they are not in the inflation indicator taken into account by monetary policy."
- Appendix figures cover tax shocks, fiscal shocks, combined shocks, and the reduction in the inflation target with the following axis ranges presented for key variables (examples preserved exactly as in source):
  - Output Gap (in percentage difference): -3.0, -2.5, -2.0, -1.5, -1.0, -0.5, 0.0, 0.5, 1.0, 1.5
  - Inflation (in percentage point difference): -3, -2, -1, 0, 1, 2, 3
  - Nominal Interest Rate (in base point difference): -300, -200, -100, 0, 100, 200, 300, 400
  - Real Interest Rate (in base point difference): -50, -30, -10, 10, 30, 50, 70, 90, 110, 130, 150
  - Investment (in percentage difference): -12, -10, -8, -6, -4, -2, 0, 2, 4, 6, 8
  - Public Debt to GDP (in percentage point difference): -14, -12, -10, -8, -6, -4, -2, 0, 2, 4, 6, 8, 10

*Source: Excerpts from _wp0872 (IMF staff paper using GIMF applied to the Czech Republic).*

### References..............................................................................................................

### _wp0872 - References

### Introduction
- Purpose: analyze monetary policy challenges in the Czech Republic amid rising inflation pressures, a fiscal reform package, and a planned reduction in the inflation target from 3 percent to 2 percent effective January 2010.
- Model used: IMF’s Global Integrated Monetary and Fiscal Model (GIMF) by Kumhof and Laxton (2007a,b), a two-country, quarterly, non-Ricardian general equilibrium model where “home” = Czech Republic and “rest of the world” = euro area.
- Paper structure (as presented): Section II reviews the environment for the CNB; Section III describes GIMF; Section IV assesses monetary implications of the fiscal reform package; Section V examines remaining macroeconomic challenges; Section VI explores implications of reducing the inflation target from 2010; Section VII concludes.

### Challenges for Monetary Policymaking
- Inflation and demand:
  - Core inflation was around 1 percent for most of 2006 but reached over 5 percent at end-2007.
  - The output gap is estimated to have turned positive in 2006 and increased steadily during 2007.
- Wages and labor market:
  - Real wage growth reached 6 percent in the first quarter of 2007.
  - Unemployment rate reached a record low below 6 percent.
  - Immigration increased since early 2005; foreign workers composition: Slovaks 47 percent, Ukrainians 25 percent, Poles 10 percent.
  - Labor shortages emerging in skilled jobs (IT, automotive) and construction; skill mismatches and lower youth labor participation contribute.
- Exchange rate and interest rates:
  - Koruna appreciation trend reversed in 2007: depreciated by 4 percent against the euro in the first half of 2007; later, koruna appreciated by about 5 percent against the euro in about two months toward end-2007.
  - Carry trade dynamics driven by ECB tightening and relatively low Czech interest rates contributed to volatility.
- Fiscal reform package (approved last August; measures described):
  - Introduction of a 15 percent flat tax rate on personal income (PIT). (Footnote: envisaged reduction to 12.5 percent in 2009 is uncertain and not considered.)
  - Increase of the lower VAT rate from 5 to 9 percent in 2008.
  - Phased reduction in corporate income tax (CIT) from 24 to 19 percent by 2010.
  - Cut in social spending by about 0.7 percent of GDP in 2008-10.
  - Increases in excises (not modeled in the analysis).
- Inflation target change:
  - CNB announced in March 2007 lowering annual CPI inflation target from 3 to 2 percent effective January 2010.
  - CNB intends inflation to descend gradually to the new target well before 2010 but has not provided a benchmark path.
- Euro adoption and ERM II:
  - Earliest feasible euro adoption date moved from 2010 to 2012; joining ERM II would be required in 2010 under the updated strategy.
  - Tradeoff between exchange rate and price stability in ERM II means major indirect tax hikes complicate the CNB’s task.
  - Looming long-term spending pressures from population aging and delays in fiscal consolidation could threaten the price stability criterion via additional demand pressures.

### Brief Description of the Model (GIMF) and Calibration
- Model features:
  - Multi-country, non-Ricardian, large-scale open-economy model with optimizing consumers and producers, sticky prices, real and nominal rigidities, monopolistic competition.
  - Agents are forward-looking but non-Ricardian; fiscal policy is countercyclical; monetary policy follows an inflation-targeting reaction function.
- Calibration:
  - Steady state GDP ratios and macro variables derived from national accounts averaged over 1995-2005/6.
  - Structural parameters adapted from literature on Czech Republic, Western Europe, United States, or Chile when Czech estimates unavailable.
  - Appendix I lists calibration variables and values.
- Fiscal sector in model:
  - Government collects taxes on consumption, labor, capital, and lump-sum taxes; spends on public consumption, public investment, and transfers.
  - Fiscal parameters set exogenously during the period to allow automatic stabilizers.
  - Long-term stability enforced through a government-set budget balance target to stabilize debt-to-GDP; sustainability requirement pushed beyond horizon of interest for short- to medium-run focus.
- Monetary policy rule and parameters:
  - CNB targets inflation rate of 3 percent in baseline.
  - Sacrifice ratio: around 1.5 (compared with 1.1 in earlier GEM calibrations and 2.1 for the euro area).
  - Monetary policy rule parameters (consistent with Czech Quarterly Projection Model):
    - interest rate smoothing coefficient iμ = 0.75
    - response to inflation forecast gap πμ = 1.4
    - response to output growth gdpmu = 0.4 (output growth used instead of output gap)
  - Euro area parameters used: igdpπ μμμ === 0.5;2;0.5

### Impact of the Fiscal Package (assumptions and main quantitative effects)
- Implementation timing and expectations:
  - Assume implementation starts in 2008Q1; because already announced, agents begin adjusting behavior and expectations as early as 2007.
- Assumed tax and transfer effects on effective rates:
  - Increase in lower VAT rate from 5 to 9 percent (a 4 percentage point hike) assumed to raise the effective VAT tax rate by 1.1 percentage point (because these goods weigh 28 percent in the consumption basket).
  - Introduction of the flat PIT assumed to decrease the effective PIT rate by 1.1 percentage point.
  - Gradual CIT reform assumed to generate a decline in the tax rate by 1.2 percentage points in 2008 and by an additional 0.4 percentage point in 2009 and 2010.
  - Social transfers to households assumed cut by 0.6, 0.7, and 0.8 percentage point of pre-shock GDP in 2008, 2009, and 2010 respectively.
  - For the exercise, tax rates are assumed not to change after the reform and benefit cuts are permanent.
- Headline inflation first-round effects:
  - First-round effects of the VAT hike could push headline inflation by about 1 percentage point.
  - In the baseline assumption, no special retailer margin behavior is assumed, so headline inflation is impacted one-to-one by the increase in the lower VAT rate.
  - Direct price effect could be spread over a more protracted period if retailers squeeze margins or mitigated by low-cost/high-efficiency international retailers ("Wal-Mart Effect").
  - Note: first-round effects are included in headline inflation shown in the graphs but are not included in the inflation indicator taken into account by monetary policy (and therefore not included in subsequent figures).
- Model results summary (directional/high-level, as given):
  - If fiscal measures implemented as announced, supply-side effects are likely to dominate demand-side effects, dampening inflationary pressures.
  - Monetary policy-relevant inflation (excluding first-round indirect tax effects) will decrease by about [text truncated at this point in source].

*Source: Excerpts from _wp0872 - References (IMF staff paper using GIMF applied to the Czech Republic).*

### 0.5 percentage point over the next two to three years and will allow a fall in nominal interest

### _wp0872 - 0.5 percentage point over the next two to three years and will allow a fall in nominal interest rate, estimated at 40 basis points in GIMF

### Fiscal package: composition and supply effects
- Tax cuts boost supply:
  - Investment increase of up to 5 percent over the next three years (due to the CIT cut).
  - Increase in labor supply from the PIT cut.
- PIT cuts increase households’ take-home pay and moderate gross wage demands by unions.
- VAT hike dampens household demand, offsetting PIT-induced demand pressures.
- Reduction in social expenditures compounds the slowdown in consumption.
- Model caveats:
  - Households in the model are assumed to refrain from demanding wage hikes following the VAT hike because the central bank ensures the inflation target is met; if this does not hold, second-round effects could emerge.
  - The model does not capture distributional impacts of tax cuts and hence not their effect on aggregate propensity to consume and timing/strength of supply effects.

### Macroeconomic effects of the fiscal shock (summary statistics)
- Fiscal balance:
  - Fiscal balance would improve by ½ percentage point of GDP over the whole period.
  - The reduction in social expenditures would more than compensate for the loss in tax revenues.
- Growth and external sector:
  - Annual growth could be spurred by over ¼ percentage point in 2009-10.
  - Combination of negative consumption demand shock and positive supply shock leads to a ½ percentage koruna depreciation, boosting net exports.
- Overall expansionary impact: the fiscal package is moderately expansionary but falls short of significant fiscal consolidation.

### Inflation and interest-rate implications of combined shocks
- Combined shocks examined in addition to the fiscal package:
  - Positive output gap of about ½ percent (from a temporary boost in consumption).
  - Wage increase of about 1½ percentage points (from current labor shortages).
  - Koruna depreciation of 2 percent in 2008 (consistent with 2007 carry trade movements).
- Inflationary pressures in 2008:
  - Overall inflation could be boosted by as much as 2½ percentage points above the target during 2008.
    - 1 percentage point derives directly from the VAT hike (first-round effect).
    - Koruna depreciation would generate close to ¾ percentage point additional inflation.
    - The positive output gap contributes ½ percentage point in 2008.
    - Wage increases contribute ½ percentage point in 2008.
- Monetary policy reaction:
  - Reaction to each of the non-VAT shocks would range from 100 to 150 basis points in 2008.
  - Overall nominal interest-rate hike could be as much as 250 basis points.
  - Peak rise in real interest rate of close to 100 basis points.
- Outcome of tightening:
  - Sharp tightening would curb inflation over 2009-10 with a return to target in 2011, but at the cost of a substantial cyclical reversal and higher real rates.

### Real economy and cycle dynamics under monetary tightening
- Monetary tightening effects through 2010:
  - Temporary boost in consumption and wages would abate.
  - Delayed effects of monetary tightening throughout 2010 push the output gap into negative territory by the end of the decade.
  - Wage shock is particularly detrimental to activity by reducing corporate profitability.
  - Real appreciation of the exchange rate and loss in competitiveness would further dampen growth.
  - Following the correction, downward wage adjustments would further reduce consumption.

### Effects of reducing the inflation target to 2 percent (CNB decision)
- Policy background:
  - CNB announced lowering the target from 3 to 2 percent from January 2010 onwards.
- Two scenarios depending on credibility/expectations:
  - Unexpected (not fully anticipated by households):
    - The model suggests stickiness may require an increase in the nominal interest rate of 75 basis points on top of earlier hikes.
    - Real interest rates would rise sharply, deteriorating the output gap by some 1½ percentage points.
    - Investment would be further hit; real exchange rate appreciation from lower domestic inflation would weigh on exports.
  - Expected (fully anticipated and incorporated by the public in advance):
    - Real effects would be negligible.
    - No action required from monetary policy authorities.
    - Inflation would start adjusting downwards as early as 2009.
    - Critical importance of CNB communication to achieve this outcome.

### Conclusions and policy recommendations
- The fiscal package by itself does not put pressure on monetary-policy-relevant inflation (excluding first-round VAT effects) but does not ease monetary policy’s task in cooling other shocks.
- Risks remain that the fiscal package could add price pressure in the context of resource constraints and a tightening labor market.
- A further reduction in the fiscal deficit would ease the burden on monetary policy in keeping inflation within target amid demand-driven pressures.
- If the 2010 lower inflation target is not fully incorporated in public behavior, monetary policy may have to tighten again, imposing short-run costs on the real economy.
- Strengthening the CNB’s communication strategy is essential to avoid short-run negative real effects and to anchor expectations to the new target.
- Fiscal policy should play a greater supportive role to monetary policy on the route to euro adoption, since nominal convergence will make it harder to fulfill the price stability criterion by monetary policy alone.

*Source: Excerpt from _wp0872 (IMF PDF).*

### Appendix Figure 1b . Czech Republic: Tax shocks, 2007-15

### Appendix Figure 1b . Czech Republic: Tax shocks, 2007-15

### Coverage and note
- Source: IMF staff estimates.
- Time span: 2007Q1–2015Q1.
- Note: "First round effects are included in the headline inflation. However, they are not in the inflation indicator taken into account by monetary policy."

### Shock categories shown
- All Taxes 1/
- VAT 1/
- PIT
- CIT

### Variables and axis ranges (as presented)
- Output Gap (in percentage difference): -1.0, -0.5, 0.0, 0.5, 1.0, 1.5, 2.0
- GDP Growth (in percentage point difference): -0.3, -0.2, -0.1, 0.0, 0.1, 0.2, 0.3, 0.4, 0.5
- Consumption (in percentage difference): -1.5, -1.0, -0.5, 0.0, 0.5, 1.0, 1.5, 2.0
- Investment (in percentage difference): -4, -3, -2, -1, 0, 1, 2, 3, 4, 5, 6
- Exports (in percentage difference): -1.5, -1.0, -0.5, 0.0, 0.5, 1.0, 1.5, 2.0, 2.5
- Imports (in percentage difference): -1.0, -0.5, 0.0, 0.5, 1.0, 1.5, 2.0, 2.5, 3.0, 3.5

*Source: IMF staff estimates.*

---

### Appendix Figure 1c. Czech Republic: Tax shocks, 2007-15

### Coverage and note
- Source: IMF staff estimates.
- Time span: 2007Q1–2015Q1.
- Note: "First round effects are included in the headline inflation. However, they are not in the inflation indicator taken into account by monetary policy."

### Shock categories shown
- All Taxes 1/
- VAT 1/
- PIT
- CIT

### Variables and axis ranges (as presented)
- Labor (in percentage difference): -0.3, -0.1, 0.1, 0.3, 0.5, 0.7, 0.9
- Capital (in percentage difference): -1.0, -0.5, 0.0, 0.5, 1.0, 1.5, 2.0, 2.5
- Labor in Tradable Sector (in percentage difference): -2.0, -1.5, -1.0, -0.5, 0.0, 0.5, 1.0, 1.5, 2.0, 2.5
- Capital in Tradable Sector (in percentage difference): -1.0, -0.5, 0.0, 0.5, 1.0, 1.5, 2.0
- Labor in Non Tradable Sector (in percentage difference): -1.0, -0.5, 0.0, 0.5, 1.0, 1.5, 2.0
- Capital in Non Tradable Sector (in percentage difference): -1.5, -1.0, -0.5, 0.0, 0.5, 1.0, 1.5, 2.0, 2.5

*Source: IMF staff estimates.*

---

### Appendix Figure 1d . Czech Republic: Tax shocks, 2007-15

### Coverage and note
- Source: IMF staff estimates.
- Time span: 2007Q1–2015Q1.
- Note: "First round effects are included in the headline inflation. However, they are not in the inflation indicator taken into account by monetary policy."

### Shock categories shown
- All Taxes 1/
- VAT 1/
- PIT
- CIT

### Variables and axis ranges (as presented)
- Public Debt to GDP (in percentage point difference): -8, -6, -4, -2, 0, 2, 4
- Wage Growth (in percentage point difference): -0.20, -0.15, -0.10, -0.05, 0.00, 0.05, 0.10, 0.15, 0.20, 0.25, 0.30

*Source: IMF staff estimates.*

---

### Appendix Figure 2a . Czech Republic: Fiscal shocks, 2007-15

### Coverage and note
- Source: IMF staff estimates.
- Time span: 2007Q1–2015Q1.
- Note: "First round effects are included in the headline inflation. However, they are not in the inflation indicator taken into account by monetary policy."

### Shock categories shown
- All Taxes 1/
- Benefits
- Fiscal Package 1/
- Tax rates (VAT, PIT, CIT)

### Variables and axis ranges (as presented)
- Inflation (in percentage point difference): -0.6, -0.4, -0.2, 0.0, 0.2, 0.4, 0.6, 0.8, 1.0
- Tax rates (in point difference): -4, -3, -2, -1, 0, 1, 2, 3, 4
- Nominal Interest Rate (in base point difference): -60, -50, -40, -30, -20, -10, 0, 10, 20, 30, 40
- Real Interest Rate (in base point difference): -10, -5, 0, 5, 10, 15, 20
- Nominal Exchange Rate (in percentage difference, +=depreciation): -1.5, -1.0, -0.5, 0.0, 0.5, 1.0, 1.5, 2.0
- Real Exchange Rate (in percentage difference, +=depreciation): -2.0, -1.5, -1.0, -0.5, 0.0, 0.5, 1.0, 1.5, 2.0, 2.5, 3.0
- Current Account (in point of GDP difference): -2.0, -1.5, -1.0, -0.5, 0.0, 0.5, 1.0, 1.5, 2.0
- Fiscal Balance (in point of GDP difference): -2.0, -1.5, -1.0, -0.5, 0.0, 0.5, 1.0, 1.5, 2.0, 2.5, 3.0

*Source: IMF staff estimates.*

---

### Appendix Figure 2b. Czech Republic: Fiscal shocks, 2007-15

### Coverage and note
- Source: IMF staff estimates.
- Time span: 2007Q1–2015Q1.
- Note: "First round effects are included in the headline inflation. However, they are not in the inflation indicator taken into account by monetary policy."

### Shock categories shown
- All Taxes 1/
- Benefits
- Fiscal Package 1/

### Variables and axis ranges (as presented)
- Output Gap (in percentage difference): -2.0, -1.5, -1.0, -0.5, 0.0, 0.5, 1.0, 1.5, 2.0
- GDP Growth (in percentage point difference): -0.5, -0.3, -0.1, 0.1, 0.3, 0.5, 0.7
- Consumption (in percentage difference): -2.0, -1.5, -1.0, -0.5, 0.0, 0.5, 1.0, 1.5, 2.0, 2.5, 3.0
- Investment (in percentage difference): -4, -2, 0, 2, 4, 6, 8, 10
- Exports (in percentage difference): -1.5, -1.0, -0.5, 0.0, 0.5, 1.0, 1.5, 2.0, 2.5
- Imports (in percentage difference): -1.5, -1.0, -0.5, 0.0, 0.5, 1.0, 1.5, 2.0, 2.5, 3.0, 3.5

*Source: IMF staff estimates.*

---

### Appendix Figure 2c. Czech Republic: Fiscal shocks, 2007-15

### Coverage and note
- Source: IMF staff estimates.
- Time span: 2007Q1–2015Q1.
- Note: "First round effects are included in the headline inflation. However, they are not in the inflation indicator taken into account by monetary policy."

### Shock categories shown
- All Taxes 1/
- Benefits
- Fiscal Package 1/

### Variables and axis ranges (as presented)
- Labor (in percentage difference): -0.5, 0.0, 0.5, 1.0, 1.5, 2.0, 2.5
- Capital (in percentage difference): -0.5, 0.0, 0.5, 1.0, 1.5, 2.0, 2.5
- Labor in Tradable Sector (in percentage difference): 0.0, 0.5, 1.0, 1.5, 2.0, 2.5
- Capital in Tradable Sector (in percentage difference): 0.0, 0.5, 1.0, 1.5, 2.0, 2.5, 3.0, 3.5
- Labor in Non Tradable Sector (in percentage difference): -1.0, -0.5, 0.0, 0.5, 1.0, 1.5, 2.0, 2.5
- Capital in Non Tradable Sector (in percentage difference): -0.5, 0.0, 0.5, 1.0, 1.5, 2.0, 2.5

*Source: IMF staff estimates.*

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### Appendix Figure 2d . Czech Republic: Fiscal shocks, 2007-15

### Coverage and note
- Source: IMF staff estimates.
- Time span: 2007Q1–2015Q1.
- Note: "First round effects are included in the headline inflation. However, they are not in the inflation indicator taken into account by monetary policy."

### Shock categories shown
- All Taxes 1/
- Benefits
- Fiscal Package 1/

### Variables and axis ranges (as presented)
- Public Debt to GDP (in percentage point difference): -8, -6, -4, -2, 0, 2, 4
- Wage Growth (in percentage point difference): -0.5, -0.4, -0.3, -0.2, -0.1, 0.0, 0.1, 0.2, 0.3, 0.4, 0.5

*Source: IMF staff estimates.*

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### Appendix Figures 3a–3d. Czech Republic: Fiscal, Output Gap, Wage and Depreciation shocks, 2007-15

### Coverage and note
- Source: IMF staff estimates.
- Time span: 2007Q1–2015Q1.
- Note: "First round effects are included in the headline inflation. However, they are not in the inflation indicator taken into account by monetary policy."

### Shock categories shown
- All shocks 1/
- Fiscal Package 1/
- Output Gap
- Depreciation
- Wage

### Variables and axis ranges (as presented)
- Inflation (in percentage point difference): -1.5, -1.0, -0.5, 0.0, 0.5, 1.0, 1.5, 2.0, 2.5, 3.0, 3.5, 4.0
- Tax rates (in point difference): -4, -3, -2, -1, 0, 1, 2, 3, 4
- Nominal Interest Rate (in base point difference): -100, -50, 0, 50, 100, 150, 200, 250, 300, 350
- Real Interest Rate (in base point difference): -20, 0, 20, 40, 60, 80, 100, 120, 140
- Nominal Exchange Rate (in percentage difference, +=depreciation): -7, -5, -3, -1, 1, 3, 5, 7
- Real Exchange Rate (in percentage difference, +=depreciation): -4, -3, -2, -1, 0, 1, 2, 3
- Current Account (in point of GDP difference): -3.0, -2.0, -1.0, 0.0, 1.0, 2.0, 3.0
- Fiscal Balance (in point of GDP difference): -4, -3, -2, -1, 0, 1, 2, 3
- Output Gap (in percentage difference): -3.0, -2.5, -2.0, -1.5, -1.0, -0.5, 0.0, 0.5, 1.0, 1.5
- GDP Growth (in percentage point difference): -1.5, -1.0, -0.5, 0.0, 0.5, 1.0
- Consumption (in percentage difference): -3, -2, -1, 0, 1, 2, 3, 4, 5
- Investment (in percentage difference): -12, -10, -8, -6, -4, -2, 0, 2, 4, 6, 8
- Exports (in percentage difference): -5, -4, -3, -2, -1, 0, 1, 2, 3
- Imports (in percentage difference): -3.0, -2.5, -2.0, -1.5, -1.0, -0.5, 0.0, 0.5, 1.0, 1.5, 2.0
- Labor (in percentage difference): -6, -5, -4, -3, -2, -1, 0, 1, 2, 3, 4
- Capital (in percentage difference): -4, -3, -2, -1, 0, 1, 2, 3
- Labor in Tradable Sector (in percentage difference): -6, -5, -4, -3, -2, -1, 0, 1, 2, 3, 4
- Capital in Tradable Sector (in percentage difference): -5, -4, -3, -2, -1, 0, 1, 2, 3, 4
- Labor in Non Tradable Sector (in percentage difference): -6, -5, -4, -3, -2, -1, 0, 1, 2, 3, 4
- Capital in Non Tradable Sector (in percentage difference): -4, -3, -2, -1, 0, 1, 2, 3
- Public Debt to GDP (in percentage point difference): -14, -12, -10, -8, -6, -4, -2, 0, 2, 4, 6, 8, 10
- Wage Growth (in percentage point difference): -4, -3, -2, -1, 0, 1, 2, 3

*Source: IMF staff estimates.*

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### Appendix Figures 4a–4d. Czech Republic: All Shocks and Reduction in Inflation Target, 2007-15

### Coverage and note
- Source: IMF staff estimates.
- Time span: 2007Q1–2015Q1.

### Shock categories shown
- Unexpected inflation
- Expected inflation
- All shocks
- Tax rates (VAT, PIT, CIT)

### Variables and axis ranges (as presented)
- Inflation (in percentage point difference): -3, -2, -1, 0, 1, 2, 3
- Tax rates (in point difference): -4, -3, -2, -1, 0, 1, 2, 3, 4
- Nominal Interest Rate (in base point difference): -300, -200, -100, 0, 100, 200, 300, 400
- Real Interest Rate (in base point difference): -50, -30, -10, 10, 30, 50, 70, 90, 110, 130, 150
- Nominal Exchange Rate (in percentage difference, +=depreciation): -4, -2, 0, 2, 4, 6, 8
- Real Exchange Rate (in percentage difference, +=depreciation): -2.0, -1.5, -1.0, -0.5, 0.0, 0.5, 1.0, 1.5, 2.0
- Current Account (in point of GDP difference): -1.5, -1.0, -0.5, 0.0, 0.5, 1.0, 1.5, 2.0
- Fiscal Balance (in point of GDP difference): -3, -2, -1, 0, 1, 2, 3
- Output Gap (in percentage difference): -3.0, -2.5, -2.0, -1.5, -1.0, -0.5, 0.0, 0.5, 1.0, 1.5
- GDP Growth (in percentage point difference): -1.5, -1.0, -0.5, 0.0, 0.5, 1.0, 1.5
- Consumption (in percentage difference): -3, -2, -1, 0, 1, 2, 3, 4, 5
- Investment (in percentage difference): -8.0, -6.0, -4.0, -2.0, 0.0, 2.0, 4.0, 6.0, 8.0
- Exports (in percentage difference): -2.5, -2.0, -1.5, -1.0, -0.5, 0.0, 0.5, 1.0, 1.5, 2.0, 2.5
- Imports (in percentage difference): -2.5, -1.5, -0.5, 0.5, 1.5, 2.5, 3.5
- Labor (in percentage difference): -3.5, -2.5, -1.5, -0.5, 0.5, 1.5, 2.5, 3.5
- Capital (in percentage difference): -5, -4, -3, -2, -1, 0, 1, 2
- Labor in Tradable Sector (in percentage difference): -5, -4, -3, -2, -1, 0, 1, 2
- Capital in Tradable Sector (in percentage difference): -2.5, -2.0, -1.5, -1.0, -0.5, 0.0, 0.5, 1.0, 1.5
- Labor in Non Tradable Sector (in percentage difference): -10, -8, -6, -4, -2, 0, 2, 4
- Capital in Non Tradable Sector (in percentage difference): -7, -6, -5, -4, -3, -2, -1, 0, 1, 2
- Public Debt to GDP (in percentage point difference): -3, -2, -1, 0, 1, 2, 3, 4, 5, 6
- Wage Growth (in percentage point difference): -10, -8, -6, -4, -2, 0, 2, 4, 6

*Source: IMF staff estimates.*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2008/_wp0872.pdf_