Assessment of the Balassa-Samuelson Effect in Croatia

The main objective of this paper is to assess the importance of the Balassa-Samuelson effect in Croatia and to quantify its influence on inflation and the real exchange rate. The productivity growth differential between tradable and ontradable sectors within a given country compared to abroad has recently often been used to explain the real appreciation of Central and East European (CEE) transition countries’ currencies against euro, and also to explain the inflation differential between the aforementioned countries and the euro area. Since all new EU member states are obligated to introduce the euro as the national currency, the Balassa-Samuelson effect associated with real convergence could impede nominal convergence and fulfilment of the necessary Maastricht criteria. The main conclusion of this paper is that in the period from 1998:Q1 to 2006:Q3 the Balassa-Samuelson effect in Croatia was not statistically significant, so it should not constitute a barrier to meeting convergence criteria