Different strokes for different folks: untangling supply and demand shocks using survey-data to assess sectoral inflationary pressures in Croatia

* The opinions contained in this paper are the authors’ exclusively and do not necessarily reflect those of the Croatian National Bank and the Bank of Italy. The authors would like to express their gratitude to two anonymous referees for their invaluable comments and suggestions, as well as to Marko Luketina, Vedran Šošić, Davor Kunovac, Milan Deskar-Škrbić, Ivana Čičak and Pave Rebić from the Croatian National Bank, to Ivan Žilić from the Institute of Economics, Zagreb and to the members of the ECB’s Working Group on Forecasting for their constructive suggestions. Additionally, the authors acknowledge the use of ChatGPT to enhance the translation, readability, and overall language quality of the paper. 

¹ Inflation expectations also play a major role in price formation: if businesses expect high inflation, they will adjust their own prices accordingly in order to make up for the increased cost of their inputs and relative devaluation of their nominal profits. That is why central bank credibility and action is crucial in preventing inflationary spirals.

² On the flipside, the output gap measure we propose is one to measure inflationary pressures, but not necessarily to reflect the state of the business cycle: the state of the business cycle, i.e., the distance between the actual output of an economy and its potential, is well measured by traditional output gap estimates, if we believe that supply shocks affect potential output directly. We therefore don’t advocate using our output gap estimate as a way to estimate potential output. The question of how temporary supply shocks are, and possibly more importantly, how large temporary supply shocks are compared to permanent ones, is still an important issue in terms of estimating potential output. As shown below, our data are agnostic concerning what level of supply factors affecting firms in our sample is temporary rather than permanent; however, what they do suggest, is that the magnitude of the temporary supply shocks that hit the EA during and after the pandemic was significantly larger than ever before. In that sense, it would suggest that potential output, at least during the pandemic, fell significantly more strongly than suggested by traditional estimates.

³ The European Commission’s business surveys gather information from firms across Europe regarding their rate of capacity utilization, i.e., a direct measure of economic slack, as well as the various factors that limit their production in a certain quarter, including insufficient demand, labour shortages, lack of equipment, materials, or space, and “other factors”. Survey data for services includes three hundred companies and for manufacturing two hundred and forty companies in Croatia. The survey is available at: https://economy-finance.ec.europa.eu/economic-forecast-and-surveys/business-and-consumer-surveys_en

⁴ We are implicitly assuming that inflation expectations are anchored throughout the sample. Introducing varying inflation expectations is the subject of forthcoming research.

⁵ We introduce the normalization for the purpose of making its magnitude comparable to a traditional output gap, to be able to overlay the two graphically. The normalization is innocuous as long as we limit our analysis to interpreting the time variation of the output gap compared to itself. We are careful, however, not to interpret its magnitude directly as the deviation of output from a level that would zero out inflationary pressures, as that would implicitly assume certain values for the elasticity of production with respect to the various shocks, which we don’t estimate here. This latter point is the subject of ongoing research.

⁶ See Box 5 in CNB (2016).

⁷ Macroprudential measures apply to all new housing and non-housing loans to consumers, and includes restrictions on the maximum monthly repayment ratio of the consumer’s total debt to income (DSTI ratio), the maximum ratio of the amount of the housing loan to the value of the property pledged (LTV ratio), and the maximum loan maturity. For more details see Box 3.1. in CNB’s publication Macroprudential diagnostics.

⁸ According to the Croatian Ministry of Internal Affairs (2025), from 1 January 2024 to 31 December 2024, 36% of the total residence and work permits issued to foreign workers were in construction, 27% in hospitality and 14% in industry.