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In this paper we provide new empirical evidence relevant for discussions on monetary policy independence in the context of euro adoption in three Central and Eastern European (CEE) countries: Czechia, Hungary and Poland. Unlike many other authors, in this paper we focus on real and not nominal interest rates as real interest rates are at the hearth of modern macroeconomic and monetary policy theory. In the paper we employ several methodologies to test the convergence of real interest rates between these countries and the euro area and to determine the main drivers of real interest rates. Based on the unit root analysis we find evidence of convergence of real interest rates in these countries, thus confirming the real interest rate parity (RIRP) hypothesis. Next, using principle component analysis (PCA) we show that common factor extracted from the sample of CEE countries and individual euro area countries can explain high proportion of real interest rate developments in these countries. Finally, results of our newly proposed analytical framework for the analysis of determinants of real interest rates in small open economies, based on a Bayesian VAR model with block exogeneity, show that external shocks have non-negligible effect on real interest rate developments in selected CEE countries. Thus, our results indicate that real interest rates in CEE depend on factors that are beyond the scope of domestic monetary policy makers. In this sense we can conclude that (conventional) monetary policy independence in these countries is limited. Thus, we see the loss of monetary policy independence as overly emphasized argument in discussions on the euro adoption in these countries. However, we are aware that national central banks in CEE started to * Received: 02-03-2020; accepted: 11-11-2020 1 Senior Economic Researcher-Advisor, Croatian National Bank, Modelling Department. Scientific affiliation: applied macroeconometrics, economic policy, macroeconomics of small open economies. Phone: +38514590313. E-mail: mdeskar@hnb.hr. 2 Teaching and research assistant, University of Zagreb, Faculty of Economics and Business, Department of finance. Scientific affiliation: public finance, fiscal policy, taxation. Phone: +385 1 238 3170. E-mail: abuljan2@net.efzg.hr. 3 Chief Advisor, Croatian National Bank, Financial Stability Department, Scientific affiliation: macroprudential policy, financial stability, macroeconomics of small open economies. Phone: + 38514564879. E-mail: mirna.dumicic-jemric@hnb.hr. Milan Deskar-Škrbić, Antonija Buljan, Mirna Dumičić • Real interest rate convergence... 350 Zb. rad. Ekon. fak. Rij. • 2020 • vol. 38 • no. 2 • 349-380 rely more on non-conventional measures recently, which gives them a higher degree of flexibility (and autonomy).

Real interest rate convergence and monetary policy independence in CEE countries