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

William Davidson Institute Working Paper 487

2. Dual Inflation — summery and discussion

In theory, the most popular explanation of the price convergence processes
involves the productivity-based inflation known as dual inflation or BS effect, (Arratibel
and al., 2001, Halpern and Wyplosz, 2001, Egert, 2002 and Backe and al., 2002 among
others)¹⁷.

Low price levels in poorer countries are determined by the lower production
capacity in the sectors producing tradable goods. Prices of tradable goods (primarily
industrial ones) are determined on the international markets, while prices of non-
tradables (mainly services) are determined at the local markets. The production capacity
in the sectors producing non-tradable goods is relatively close in both countries of low
and high per capita income. The low productivity of tradable goods in poorer countries
reflects on the low salary levels in the sector and on the low prices of non-tradable goods,
and hence low overall price levels. This is the static theoretical picture of the BS effect
(i.e. BS effect in levels - static BS).

Figure 3. Labor productivity in Bulgaria

¹⁷ While Balassa focuses more on salaries and production capacity in the tradable and non-tradable
sector in the developed and developing countries, Samuelson discusses the same processes from the
point of view of production factors’ movements (labour and capital). For more details see Bartolini
(1995), Benaroya and Janci (1996), ECB (1999), Busson and Villa (1996), Aglietta and al. (1998),
Couder (1999).

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