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By Luke Heighton
     FRANKFURT(MNI) - The European Central Bank risks being caught with its
policy at too loose a setting to be able to respond to an inevitable downturn,
the governor of the Central Bank of Croatia told MNI.
     "If the cycle turns and monetary policy is still in this very long
expansionary cycle, how will it respond?" Boris Vujcic said in an interview
earlier in December. "If interest rates are at, or close to, zero, you won't
have much monetary policy space to react."
     Vujcic, who sits on the ECB's general council as Croatia applies for euro
membership, cited both fiscal indiscipline and structural weaknesses, alongside
a slowing world economy and trade tensions, as key factors retarding eurozone
growth at a time when the end of a cycle sustained by ultra-low interest rates
and quantitative easing might be approaching.
     "Since the beginning of the financial crisis we've had a very long cycle of
very expansionary monetary policy, yet it is difficult to believe that the real
economic cycle can last so long," he said, adding that, with interest rates
already near the lower bound, a downturn might leave little alternative to
another dose of unconventional monetary policy.
     The effectiveness of this, however, would be hampered by the incomplete
nature of the eurozone's monetary union. The use of the ECB's largest
unconventional weapon - quantitative easing - has been limited by the lack of a
single eurozone sovereign bond, a constraint not faced, for example, by the
Federal Reserve.
     "In spite of much that has been done to make monetary union more complete
and resilient since the beginning of the crisis, the question of the
completeness of monetary union is still very much alive," he said. "And this is
where this kind of battle of the [economic] cycles will bring, in my view, this
question to the surface at some point which might not be very far away."
     Croatia's own progress towards joining the monetary union is proceeding
apace. The country expects to be able to join the ERM II exchange rate
mechanism, a step prior to euro membership, some time in 2020.
     "In our view Croatia is the country that stands to benefit most from euro
adoption of all countries which are still not members of the currency bloc," he
said, adding that the majority of Croatian bank deposits are already held in the
common currency.
     "We are the smallest country in the EU that has not yet adopted the euro.
We are the most euro-ised of all of them," he said, adding that high levels of
euro-denominated debt will also be easier to manage once the country joins the
currency area.
     "All that risk disappears at the moment of entry," he said, adding that
Croatia "will feel the large drop in the cost of financing with the removal of
that risk."
     In preparation for joining the euro area, Croatia has reduced public debt
ratios and turned a current account deficit into a surplus. But demographic
change has been a problem, with over 150,000 Croats leaving the country since it
joined the EU in 2013. More immigration is required, he said, as well
improvements to the education system.
     "The government is increasing its immigration quotas now, but it's not easy
to find a proper labour force, although there are more and more of them coming,"
he said, adding that both Croatia and the EU needed "a smart immigration
--MNI London Bureau; +44 203 865 3829; email:
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