The paper estimates the money demand in Croatia using monthly data from 1994 to 2002. A failure of the Fisher equation is found, and adjustment to the standard money-demand function is made to include the inflation rate as well as the nominal interest rate. In a two-equation cointegrated system, a stable money demand shows rapid convergence back to equilibrium after shocks. This function performs better than an alternative using the exchange rate instead of the inflation rate as in the 'pass-through' literature on exchange rates. The results provide a basis for inflation rate forecasting and suggest the ability to use inflation targeting goals in transition countries during the EU accession process. Finding a stable money demand also limits the scope for central bank 'inflation bias'.

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commercial banks, credit rationing, latent variable models, loan assessment, small and medium enterprises., C31, C51, C52, G21, H81,

The paper proposes a time series generalisation of the structural equation model with latent variables (SEM). An instrumental variable estimator is considered and its asymptotic properties are analysed. Special emphases are placed on the potential use of the lagged observed variables as instruments and consistency of such estimation is established under some general assumptions about the stochastic properties of the modelled variables. In addition, an identification procedure suitable both for static and dynamic structural equation models is described. The methods are illustrated in an empirical application to dynamic panel estimation of a consumption function using UK household data.

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