Abstract
Despite almost 10 years of low inflation, Croatia continues to experience high levels of dollarisation/‘euroisation’. Roughly, three-quarters of bank deposits and currency in circulation are held in foreign currency. This limits the manoeuvering room for monetary policy. Banks try to avoid balance sheet mismatches by indexing lending to the exchange rate, but this creates credit risk. In addition, strong currency depreciation could lead to flight from the currency, and inflation pass-through, while apparently moderate in recent years, could easily become a problem. Policy options, including adopting the Euro as the official currency, inflation targeting, and the present policy of a limited dirty float, are discussed.
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Notes
To be precise, the arrears were cleared by a combination of cash payment, netting of claims and issuance of bonds.
In fact, the banks generally extended the deadline for free conversion via depositing to 31 March 2002, the official end of the conversion period for most of the ‘Euro-in’ currencies.
About 80% of FCC was in ‘Euro-in’ currencies, so that an estimate of total FCC is correspondingly larger than the estimated amounts of ‘Euro-in’ currencies converted to Euros.
See Feige et al. (2002b) for an elaboration of a formal network externalities model and an application to Argentina. Also, Oomes (2001) finds that the network externalities model fits the data for Russia better than a ratchet/hysterises model.
The Croatian National Bank requires that banks' open positions be less than 20% of regulatory capital.
Billmeier and Bonato (2002) employ a similar model, and then add a VECM to obtain long-term results. They find a long-term cointegration relationship, and estimate that a devaluation of 10% would imply a rise of RPI inflation of 0.6 percentage points in the long run. The authors do point out that their estimated coefficients are higher than in other similar economies such as Slovakia. Nonetheless, they do not seem to correspond to the highly indexed economy that is generally expected.
‘Tying one's hands’ comes from Giavazzi and Pagano (1988), and ‘Has Monetary Policy Been So Bad That It Is Better To Get Rid of It’ is from del Negro and Obiols-Homs (2001).
In a rather different context, de Zamaroczy and Sa (2002) note that Cambodia continues to suffer from very high interest rate spreads despite near complete (unofficial) dollarisation. This highlights the need to consider country risk as well as currency risk.
I would like to thank Curzio Giannini for helpful discussion of this issue.
In fact, at a recent conference, Jurgen van Hagen pointed out that once a common currency is adopted, the term inflation should be reserved for inflation in the whole zone of operation of the currency, not the individual countries. Inflation, he reminds us, is the change in the value of money relative to goods.
Croatia submitted its application for EU membership in the first half of 2003.
To be precise, the ECB's policy has two pillars, an inflation target and monetary aggregate targets.
An interesting discussion based on this issue was the Israeli experience found in Frankel (1999).
For example, the Bank of Canada (1991) justifies focusing on core inflation with the argument that it is less volatile than the CPI as a whole, and therefore provides more insight into inflationary trends.
Net inflation indexes are used in Canada, the UK and the Czech Republic.
IMF (2000) notes that most non-industrial countries target headline inflation for transparency reasons.
The Czech Republic began targeting core inflation, but switched to headline inflation in April 2001.
This issue and other practical issues of inflation target implementation are discussed in Blejer et al. (2000).
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1I thank without implicating Katja Gattin-Turkalj, Vedran S̆os̆ić, Maroje Lang, Paul Wachtel, Krešimir Z̆igć and an anonymous referee for comments and input. All remaining errors are the author's. This paper does not necessarily reflect the views of the Croatian National Bank.
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Kraft, E. Monetary Policy under Dollarisation: The Case of Croatia. Comp Econ Stud 45, 256–277 (2003). https://doi.org/10.1057/palgrave.ces.8100023
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DOI: https://doi.org/10.1057/palgrave.ces.8100023