Market Monetarism has come to Croatia, but unfortunately not to the Croatian central bank

Good news – the Market Monetarist gospel is spreading across the world. The latest arrival is Petar Sisko’s blog Money Mischief in Croatia. Petar blogs both in English and in Croatian. Petar has been a frequent commentator on my blog so I am happy that he is now taking the Market Monetarist message to Croatia. I like the fact that Petar has named his blog Money Mischief – undoubtedly after Milton Friedman’s book. Money Mischief is one of my favourite books on monetary matters and I strongly considered naming my blog Money Mischief when I started it in 2011.

Croatia certainly needs a shot of Market Monetarism. Since 2008 Croatian monetary policy has been extremely tight. Just take a look at the graph below.

Croatia NGDP RGDP

Prior to when the crisis hit in 2008 the Croatian central bank (CNB) kept nominal GDP growth around 8% – more or less evenly split between 4% real GDP growth and 4% inflation.

However, since 2008 nominal GDP has barely grown. Since the central bank is in full control of nominal GDP the stance of the CNB since 2008 can only be termed extremely tight.

This is certainly also visible on the price level. From 2000 to 2007 inflation – measured with the GDP deflator – averaged around 4%. However, since 2008 inflation has dropped well below 4% and has averaged 2%.

Price Level Croatia

Obviously one could argue that inflation of 2% is preferable to 4% inflation and that 6% NGDP growth is preferable 8%. However, the shift in NGDP growth and inflation does not reflect the announcement of a new target, but rather a negative shock to monetary policy and that I believe is at the core of the Croatian crisis.

The best way to pull the economy out of the crisis is for the CNB to announce a 6% NGDP level target – and allow the Croatian kuna to float much more freely than is presently the case.

Over the longer run that would keep inflation around 2% as I think it is fair to think that trend real GDP growth is 4%.

I am sure Petar’s blog will help further the discussion about monetary policy and that should be welcomed.

PS If somebody asks why the CNB has not implemented more aggressive monetary easing then the answer probably is that the CNB fears weakening the Croatian kuna (the CNB is de facto operating a managed float/quasi-pegged exchange rate regime). Croatian households and corporations are heavily indebted in foreign currency. Hence, the CNB undoubtedly fears setting off a financial sector crisis if the kuna were to weaken significantly on the back of more aggressive monetary easing. I think those fears are unfounded, but that is another story that I might return to at a later stage.

PPS here is my old friend Boris Vujcic who since 2012 has been CNB governor in an interview with CNBC from last year on Croatian monetary policy. I say ‘old friend’, but don’t blame Boris for my views.

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