Dual Inflation Under the Currency Board: The Challenges of Bulgarian EU Accession

Abstract

The importance of analysing inflation sources and dynamics in Bulgaria is imposed by (i) the long run process of price and inflation convergence to the Euro area and (ii) by the Currency Board operating in the country. In this study we make an attempt to estimate Balassa - Samuelson (BS) effect in Bulgaria (after the introduction of the Currency Board). The BS explanation of inflation (or dual inflation) has acquired both academic recognition and popularity in practice in the recent years. The results of our empirical estimation do not provide a robust verification of the existence of BS effect in spite of the observed prerequisites and the accompanying economic indicators interrelations. Actually there are several factors that interfere with the BS effect lying in the wage convergence process in both sectors and others that influence productivity developments in the sectors. This prompts that the price movement in the country has other driving motions – above all wage setting and incomplete price liberalization, other factors productivity, imported inflation (pass trough) and inflation generated by the temporary gaps between money demand and money supply.