Abstract
The impact of exchange rate changes in small open economies has been a widely researched topic for decades. According to economic theory and relevant research, depreciation can have a positive impact on the economy through an increase in exports, and a negative effect through decrease in an individual consumption. The aim of this article is to assess the impact of exchange rate depreciation on external debt in Croatia in the long-run. The long-run impact of depreciation on external debt in Croatia is assessed using Johansen cointegration approach. The results point to the existence of one cointegration relation. The long-run impact of exchange rate depreciation on external debt in Croatia is statistically significant and positive, what is in line with previous research and economic theory. The conducted analysis outlines the possible negative impact of depreciation on Croatian economy through the increase of external indebtedness, what could consequently decrease the wealth of all sectors indebted in foreign currency. Since Croatia is a highly euroised small open economy with high external indebtedness in foreign currency, this research provides captivating results for monetary and fiscal policy-making in Croatia. Therefore, as a result of the conducted empirical analysis, the exchange rate depreciation in Croatia is not recommended as the instrument of increasing export competitiveness due to current high external indebtedness in foreign currency.
Highlights
The question of the impact of exchange rate fluctuations on overall economy has been the subject of much debate among academic researchers and economic policy makers for decades
The exchnage rate depreciation could have twofold effect on overall economy according to economic theory and empirical reserach, and the exchange rate management is one of the important economic policy question, especially in case of small open economies such as Croatia, which are highly dependent on foreign sector
The impact of depreciation on external debt in Croatia is examined in this article using Johansen cointegration approach
Summary
The question of the impact of exchange rate fluctuations on overall economy has been the subject of much debate among academic researchers and economic policy makers for decades. Marshall-Lerner condition implies that exchange rate depreciation should foster economic growth through an increase in net exports [1]. On the other hand, the exchange rate depreciation leads to an increase of liabilities denominated in foreign currency. In case of accumulated foreign currency debt, currency depreciation might have overall negative effect on the economy. In many Eastern European economies, including Croatia, high external indebtedness in foreign currency is present. External debt represents a problem which is in focus of economic policy making for all European Union candidate countries, as well as for European Union member countries which are on its way of accession to Euro area, such as Croatia
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