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An Assessment of Monetary Policy in Croatia with Reference to Euroisation

This thesis investigates recent monetary policy in Croatia and assesses some of the results achieved. The Croatian monetary authorities have been remarkably successful in achieving and maintaining low inflation, having outperformed most other transition economies. Hence on this basis the conduct of monetary policy in Croatia should be assessed as successful. However, the relatively low confidence in the domestic currency suggests that this ‘ success’ should be interpreted with caution. Although monetary policy in most transition economies has begun to converge on that practised in developed market economies, there are some distinctive features in transition economies which may make the conduct of monetary policy quite different. Unofficial euroisation stands out as the most important candidate. Croatia is the most euroised economy in Central and Eastern Europe. This unique feature complicates the conduct of monetary policy and leads to the monetary authorities targeting the exchange rate. It is in this context that an investigation of the consequences of euroisation for monetary policy is undertaken in this thesis. This investigation suggests that euroisation constrains the conduct of monetary policy and the degrees of freedom for autonomous monetary policy are low. This is due to the identified currency mismatches in the economy which imply that there are high risks in letting the exchange rate float, even threatening the possibility of a fully fledged financial crisis. It is also argued that a stable demand for domestic money function is not to be expected and an empirical investigation of both the demand for narrow and broad money in Croatia largely supports this hypothesis. Another important consequence of euroisation is the absence of strong channels of the monetary policy transmission mechanism. An empirical investigation of the exchange rate, interest rate and credit channel in Croatia suggests that they are very weak or nonexistent, confirming that the effects of monetary policy in the euroised environment may be different from what is usually expected. This thesis has identified some of the risks that the monetary authorities in the euroised environment are faced with. Given these risks and the finding that the impact of monetary policy in Croatia is weak, the official introduction of the euro seems a prudent step forward. The arguments developed in this thesis not only apply to the Croatian case, but should be taken as relevant to any economy with a high degree of euroisation.

Monetary policy; euroisation; Croatia

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