Research Department, Croatian National Bank, Trg Burze 3, 10002 Zagreb, Croatia. E-mail: evan.kraft@hnb.hr

¹I thank without implicating Katja Gattin-Turkalj, Vedran oi, Maroje Lang, Paul Wachtel, Kreimir ig 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.

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.