Comments on “Should the CNB devalue the exchange rate Comments on “Should the CNB devalue the exchange rate?” by Tkalec and Vizek Kenichi Ueda International Monetary Fund Young Economists Seminar, Dubrovnik, June 23, 2010 The views expressed in this paper are those of the authors and should not be attributed to the International Monetary Fund, its Executive Board or its management.

Summary of the Paper The paper investigates whether and how PPP hypothesis holds in HRK/EUR. Thoroughly investigated the issue using “error correction” framework. PPP holds in the long run. In the short run, ex rate appears to adjust given exogenous domestic and EMU price levels. Authors conclude that it is the domestic price level that needs to adjust. Then, PPP will hold. And thus, the current “managed float” does not need to be changed.

Comment 1: Deaton Critique (meas error) Different consumption basket across countries made PPP study difficult. Are Croatia’s and EMU’s goods the same? If not, PPP is not perfectly measured. If yes, it may be the case that some goods are “too exotic” (and thus “high” price) in Croatia/other country. As an economy rapidly grows, consumption basket changes. Additional difficulties to compare PPP between advanced and transition economies.

Comment 2: Lucas Critique (endogeneity) To adjust the price level, it is inevitable to start with lowering public sector wages as well as to shrink the public sector. The large adjustments or “change in price” is likely to correct the short-run error from the PPP. So, after the adjustment, the regression results could reverse. Need to think about theory, too.

Comment 3: A deeper question: best policy Difficult trade-offs, but manageable Competitiveness  better to devalue ex rate Euro denominated debt  better to keep ex value However, rigid labor and product markets due to large presence of government can be improved. Lower wages can improve competitiveness although they would make people difficult to repay debts. But, this potential NPL problem can be mitigated by higher and more steady growth, which can be brought by more flexible labor and product markets (more on this).