PREFACE 2 LET'S SHARE EXPERIENCE AND IMPROVE MUTUAL UNDERSTANDING

The Czech and Chinese economies are different in many respects：while the first is a small open economy in the middle of Europe with strong ties to other EU countries，China is a large economy affecting global foreign trade and global economic development in general. China has 50 times larger GDP（inUS dollar terms），130 times more population and even 150 times more workers than the Czech Republic. Despite these breath-taking differences，we believe that some economic topics may be common to both economies，and that each of the two economies can learn from the developments in the other. Indeed，some issues are not so much related to the size of the economies，but rather to the specific position of emerging economies，which，moreover，have undergone a large number of reforms in the recent past and which have fully engaged in international trade and to some extent the international financial system only in the last three decades.

In the chapters，which are devoted in more detail to the Czech Republic，we describe mainly the development and problems of monetary policy and issues of regulation of the domestic financial system. Although，of course，the development described was specific to the Czech Republic，we believe that much of what the Czech economic policy had to face is of a more general nature and can be seen as lessons for other emerging countries.

An example of such a more general problem is the inflow of foreign capital into an emerging economy，which can lead to unintended complications after the economy opens to global financial markets. Particularly，in the Czech Republic it was necessary to sterilize expensively the inflow of capital so that it did not lead to excessive appreciation of the exchange rate，but excessive growth of foreign exchange reserves and the problem of the so-called impossible trinity arose. The excessive inflow of foreign capital sterilized by the Czech National Bank led to a loss of autonomy of the monetary policy and ultimately to abandoning the fixed exchange rate，which was accompanied by the currency crisis at the end of the 1990s. This development leads to more general questions：Was the emerging economy open to international financial flows too early？Is there any optimal moment at which the economy should be fully open to international financial markets？And what really are the advantages and risks of this integration into global financial markets？These questions remain unsettled but the experience of the Czech Republic could give at least some insights into this subject，albeit not definitive.

Another lesson the Czech monetary policy had to learn was the inflation targeting as a new monetary policy regime. Again，although specific in its historical details，the lesson can be more general for emerging countries. Is inflation targeting convenient for an emerging economy？Is it possible to implement this regime in an environment with substantial data uncertainty？And what forecasting models should be used and how to construct these models？Although it can be said that the regime of inflation targeting was by and large a success in the Czech Republic，the central bank had to gain substantial experience before the new regime of the monetary policy was fully established by trial and error. In fact，inflation rate was，in the initial phases mostly lower than the inflation targets，which probably needlessly reduced economic growth. But despite these shortcomings，history has shown that it is possible to implement inflation targeting in an emerging economy even though the preconditions for it are not（and cannot）be perfect. Obviously this is not to say that inflation targeting is the only correct monetary policy regime convenient for any emerging economy but the historical experience made by the Czech central bank could be at least informative for others.

Even though inflation targeting has been well established，the Great Financial Crisis in 2008 has shown that it is not “the end of history” in the field of monetary policy. The Great Financial Crisis was a severe test of monetary policies both in developed and emerging countries. Interest rates were reduced down to zero in many countries including the Czech Republic. This led to a more general question what should the central banks do when their main tool，i.e. interest rates，is out of the game. The Czech monetary policy opted for a so-called exchange rate commitment，i.e. it set a minimum threshold for the exchange rate and kept it by means of foreign exchange interventions for several years. Again this is not to say that this is the only way to tackle the zero lower bound restriction of monetary policy in an emerging economy，but experiences made by the Czech central bank when using this tool could be helpful for other emerging economies if they were in a similar situation.

The option of negative interest rates is another option for monetary policy in case of economic slump.Can interest rates become sufficiently negative and what consequences would this have？Despite the fact that neither China nor the Czech Republic currently faces the zero lower bound problem for interest rates，this question could become rather important in the next economic slowdown of the world economy，which sooner or later will arrive.

The banking sector or the financial sector in general has its specifics in an emerging economy，regardless of whether it is a large economy such as China or a small open economy such as the Czech Republic. First of all，there is a general question of how big the financial sector should be. Too small financial sector is curbing economic development because it does not act as a sufficient intermediary between those with free capital and those with investment opportunities. On the other hand，if the financial sector is too large，it can make the economy very vulnerable（as it became clear during the Great Depression in 2008）. There is a proportional relationship（although not very strong）between the state of development of the economy and the size of the financial sector（in terms of GDP），so it is clear that the financial sector is growing slightly faster than GDP in emerging economies. Nevertheless，it is not clear what the optimal size of the financial sector in the emerging economy is. However，it is certain that the financial sector can be a source of a serious misallocation of capital，and the real estate bubble is perhaps the most serious example of such a misallocation. Therefore the question is what kind of regulation should the emerging economy authorities choose in order not to stifle the rapidly developing mortgage market，but at the same time in order to dampen or prevent the emergence of real estate bubbles？This book gives an overview of several measures taken to prevent the real estate bubble in the Czech Republic，although their actual impact is not yet fully known. Similarly，a new challenge for emerging economies will be to implement macroprudential measures，which may sometimes be in conflict with traditional monetary policy.

Emerging economies have to face problems and questions，which are to some extent similar. Obviously，experiences of individual emerging economies are necessarily specific because of different historical situations，different international relations，traditions and other factors. Yet we believe it is useful for them to share their experiences mutually. Although this volume deals only with selected economic topics from China and the Czech Republic，we believe it could contribute to sharing the experiences and thus improve mutual understanding.

Vladimír Tomšík

Ambassador of Czech Republic to China，

Former Vice Governor of Czech National Bank

Beijing，January 18，2020