Keywords

projection model, unconventional monetary policy rule, nominal exchange rate, euroization

This paper provides the documentation for a Quarterly Projection Model (QPM) used in regular forecasting exercises in the Croatian National Bank. The proposed model is a reduced-form representation of an Open Economy New Keynesian general equilibrium model, expanded with some ad hoc features in order to capture empirical evidence about the Croatian economy. Special attention is paid to open economy features of the model, financial stability issues related to the high degree of credit euroization and monetary policy modeling. The main contribution to the existing literature is the monetary policy rule, which is represented by an exchange rate reaction function with a slow-moving exchange rate target. The simulation and forecasting exercises conducted in this paper show that the model is able to produce precise forecasts of the main macroeconomic variables and to explain important relationships and the transmission mechanisms of the Croatian economy.