Non-linear effects in the Croatian inflation-generating process

The inflation-generating process in Croatia is extensively covered in the literature. However, two main shortcomings characterise the majority of these studies. First, none of them make the effort to directly measure inflation expectations and include them in the inflation model specification. Second, they completely disregard potential asymmetric effects in the Croatian inflation-generating process. This paper adds to the literature in terms of both mentioned niches. Inflation expectations are obtained directly through the consumer surveys. The smooth transition regression (STR) is applied to inspect for possible non-linearities in the Croatian Hybrid New Keynesian Phillips curve (NKPC). It is found that the pivotal role in the inflation-generating process can be assigned to expected inflation: as the inflation expectations increase, their effect on actual inflation significantly intensifies, while the impact of inflation persistence smoothly fades away. Inflation persistence is, however, also relevant, while the output gap parameters are not significant at all.