We Need a Package of Measures to Reduce Interest Rates and Increase GDP

Gross domestic product (GDP) has been continuously declining since 2009. If it falls by one percent this year, as forecasted by the European Commission, the cumulative real decline in GDP from 2009 to 2013 will be 11.4 percent.

At the same time, from July 2008 to June 2013, 170.7 thousand jobs were lost. These and other economic indicators indicate that the Croatian economy is in deep crisis. Unfortunately, there are no signs of changes that would signify economic recovery, growth, and development. A prerequisite for resolving the crisis and growth of changes is economic policy, or rather the economic model.
The goal of economic policy since the early 1990s, especially since the introduction of the kuna and the Economic Stabilization Program, has not been growth, but price (and exchange rate) stability. This can be supported by data showing that in approximately a twenty-year period, up to 2013, foreign indebtedness was around 115 billion euros, and GDP in 2013 will be 0.8 percent lower than in 1989. Thus, foreign borrowing has not been in the function of growth and development.

Development Paradox The economy can be described by external debt, which amounts to about 100 percent of GDP, where the annual total need for foreign (re)financing is approximately one-third of GDP, with the state alone needing to finance an additional more than five billion euros in deficit over the next two years. In economics, this is referred to as external imbalance (Mundell-Fleming model). The consequence of such maintained balance is a decline in economic activity and job losses. Therefore, in the Croatian economic model, growth and employment are not objectives. This is a development trap and a development paradox.
The problem of interest rates is one of the crucial factors that will affect overall finances. Namely, from 2009 to 2013, during the economic crisis, interest rates were between six and eight percent, and there was no economic growth, meaning the economic decline stopped (see table). It would be financially sustainable if the implicit interest rate (on public debt) were at most at the level of economic growth; otherwise, the disproportion between interest rates and growth to the detriment of growth threatens the sustainability of finances. The continuation of such relationships, where interest rates are significantly higher than economic growth, is not financially sustainable, is a dangerous trap, and further (pro)decline will cause a collapse.
Many policymakers are proposing investment initiatives. Since 2008, gross investments have fallen from 30.4 percent of GDP to 17 to 18 percent, and gross national savings from 22.2 percent of GDP to 14 to 15 percent. This cannot ensure either growth or employment, especially with such high interest rates.

Collapse of Supply and Demand Data shows that there has been a collapse of aggregate supply (AS) and demand (AD), therefore, as a prerequisite for further considerations, it is necessary to analyze and establish new relationships between IS and LM (investment, savings – liquidity, money), with a new model, or rather economic policy. The increase in investments has mostly been a result of foreign capital inflow. However, the analysis of the relationship between IS and LM using the model ???? highlights a particularly important fact that from 2000 to 2011, capital contributed 2.3 percent to GDP growth, technological progress 0.2 percent, and labor zero percent. Thus, knowledge and labor did not contribute to growth, while foreign accumulation achieves goals in interest rates. Such an investment policy must be fundamentally changed.
Starting from the fact that in the goods market (IS) the interest rate is not determined by the money that can be lent, but by a set of possible combinations of interest rates and GDP, with a lower interest rate corresponding to a higher GDP, and that in the money market (LM) the interest rate is not determined by liquidity preference, but by a set of possible combinations of interest rates and GDP, and that the overall relationship between IS and LM is important, the new economic model being proposed is aimed at implementing measures that jointly connect GDP growth with lower interest rates. This mostly resolves domestic employment as well.
Since there has been no economic development in the last twenty years, which has never happened in almost two hundred years of Croatian economic history, it is inevitable to implement changes aimed at stopping the economic decline and shaping economic growth and development, thereby resolving the crisis.
Only a part of the economic model related to savings and investments has been briefly presented, which is particularly important for the private sector as foreign investments cannot be a growth factor. For shaping a sustainable economic policy, the key element is IS, investments – savings, as part of the new economic model, conceived according to the principles of modern economics.