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

Dual Inflation under the Currency Board
The challenges of Bulgarian EU accession

Nikolay Nenovsky
Kalina Dimitrova^*

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.

JEL classification: C 22, E 24, E 42, F 15.

Keywords: inflation, currency board, EU accession, Bulgaria

Nikolay Nenovsky (Bulgarian National Bank, Sofia University of National and World Economy
and University of Orleans, France), ([email protected] or [email protected]); Kalina
Dimitrova (Bulgarian National Bank), ([email protected]). We would like to thank for the
comments on the first version to Georgi Petrov, Neven Velev, to the participants at University of
Orleans (LEO) seminar held on 12 March 2002, and especially to Philippe Saucier, Jean-Baptist
Desquilbet, Raphaelle Bellando and Patrick Villieu. And for the comments of the revised version of
the paper, we thank all participants of the workshop on convergence held at the University of
Thessaly, Volos on 22 June 2002.

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