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

William Davidson Institute Working Paper 487

countries determined by market segmentation and competitiveness²¹. The policies of
price control and protection of industries producing tradable goods pursued by
governments leads to violation of the LOOP and consequently to weaker (if any) BS
effect.

There is a series of research papers studying the BS effect in Central and Eastern
European countries. For instance, IMF (2000) estimates the effect for Slovenia of 2.5%
percent per annum. According to the precise estimates of Pelkman and al. (2000), BS
effect of around 3.5-4% is observed among the candidate countries. Simon and Kovacs
(1998 and 2000) estimate the BS effect for Hungary at 1.9 percent per year during the
period 1991-1998. According to Arratibel and al., 2001, the BS effect in five Central
European countries is about 1-3% and it could be explained by a half of the inflation
differential between the Euro area and these countries. More recently Egert (2002)
estimated BS effect to be close to zero for the Czech republic, Slovakia and Slovenia, and
around 1% and 3% for Hungary and Poland (the period of investigation is1991:Q1 to
2001:Q2). In some of those papers, Bulgaria is included in the general conclusion of
positive BS effect existence. However, up to the moment there is no direct econometric
estimation for Bulgaria.

3. Empirical foundations of the estimation of dual inflation under the CB

In this paper we try to evaluate the BS effect in Bulgaria. Our estimation could be
seen as an attempt to contribute to the discussion about the BS effect, which in some
aspects is crucial for accession countries with fixed exchange rates. It is not a coincidence
that recently Van Duisenberg said in his speech that "...what is known as the “Balassa-
Samuelson effect”, that is, the potential inflationary pressures arising from higher
productivity growth in catching-up economies, has also been held responsible for higher

²¹ See Dobrinsky (2000).

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