This paper analyses the mechanisms of monetary transmission in Croatia. Monetary transmission is a system of functionally related variables explaining the influences that changes in money supply and money demand have on non-monetary variables. The primary element of monetary transmission is a shock to monetary equilibrium caused by changes in money supply which are the result of different measures in monetary policy or changes in money demand. Its final element is the re-establishing of monetary equilibrium through prices and real variables, which affects the national product (Baleti?, 2004).
The study of monetary transmission is of great importance for monetary authorities since a good knowledge of its characteristics allows them to stabilise unfavourable economic fluctuations in an efficient way and in due time as well as to favourably affect prices and the real activity. Furthermore, an insight into monetary transmission enables them to anticipate the effects of monetary policy measures, which is indispensable for implementing the inflation targeting regime introduced by several transition countries (the Czech Republic, Slovakia, Hungary and Romania).
The paper also addresses the problem of empirical research of monetary transmission mechanisms, i.e. exchange rate channel, interest rate channel and direct monetary transmission in Croatia. Bearing in mind that the structure of Croatian economy is somewhat similar to the small and open economies of Central and Eastern European (CEE) countries that are characterised by a developed bank system, an underdeveloped financial market and the presence of unofficial euroisation, the results should confirm the hypothesis that Croatia is similar to those countries regarding the activity of monetary transmission channels as well. Therefore, it is expected that, in addition to the direct monetary transmission, the exchange rate channel will be of the utmost importance in monetary transmission.
The characteristics of Croatia, such as the “fear of floating”, the monetary policy aimed at maintaining stability of the exchange rate and a significantly higher level of euroisation additionally contribute to the assumption about the importance of the exchange rate channel in monetary transmission. On the other hand, high interest rate volatility on the money market, a lack of Croatian National Bank’s (CNB) referent interest rate until 2005 and a great competition on the bank market in the last couple of years indicate there is a small probability that the interest rate channel will be active.
The lack of CNB’s referent interest rate and open market operations until 2005 are the characteristics that differentiate Croatian monetary system not only from most of the CEE countries, but also from the EU-15 countries where the interest rate channel is the dominant way of transmitting monetary policy impulses on prices and the real economic activity.
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