THE ROLE OF EXTERNAL SHOCKS IN CROATIA: BLOCK EXOGENEITY SVAR APPROACH

The aim of this paper is to analyze the impact of foreign shocks on the Croatian economy in the last decade. The Croatian small open economy (SOE) does not affect prices nor other macroeconomic variables of the foreign sector, but its economic activity depends on foreign economic trends. The crucial characteristic of the small open economy is the exogeneity of foreign variables for the domestic economy, whereat foreign variables impact the domestic economy while the restriction of the model is that domestic variables do not impact foreign variables. Therefore, the structural vector autoregressive (SVAR) model is estimated in order to assess the impact of foreign shocks on the Croatian economy. The impact of the euro area and income and price shocks is analyzed, with the emphasis on the relative importance of domestic versus foreign shocks. The impulse response functions and the variance decomposition analysis have confirmed that the foreign variables have a substantial impact on domestic variables and that the inclusion of the euro area variables is necessary for macroeconomic modelling of the Croatian economy.