Monetary and fiscal policy mix in a small open economy: Case of Croatia

Croatia is a small open economy on the verge of joining the European Union. Interest in the research of economic characteristics and features of economic policy in Croatia stems from the fact that this is the next transitional country that enters the EU and, in the context of the present European crisis, Croatia is perceived to have structural characteristics of a Mediterranean periphery country. Also, Croatia is the only country in Europe, besides Greece, that haven’t managed to achieve economic growth for the fifth year in a row. In this paper we use Mundell-Fleming theoretical framework and structural VAR methodology to analyze the possibilities of monetary and fiscal policy in achieving main economic policy goals in Croatia. Precisely, the main goal of this paper is to analyze the possibilities of the monetary and fiscal policy mix to achieve macroeconomic goals of price stability and economic growth, which are very important in the context of  (quasi)stagflationary recession in Croatia.

In order to identify structural VAR model, i.e. to impose sufficient (appropriate) number of restrictions, we combine conclusions and predictions of Mundell-Fleming model and information on structural specificities of Croatian economy.  Our results indicate that both policies in Croatia could stimulate economic growth, without endangering the goal of price stability (through the exchange rate mechanism), i.e. there is a possibility for coordinated activity of the policies in order to achieve both macroeconomic goals. In the context of the current economic situation, that would mean that the expansionary economic policy could speed up the process of getting Croatia out of recession without inducing further inflationary pressures.