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

William Davidson Institute Working Paper 487

It is evident form the coefficients that the non-tradable goods and services have a
very weak and positive influence on the real exchange rate (PNT/PT)²⁷. We can also
observe that the influence of the productivity level in the tradable sector on the real
exchange rate is weaker than the influence of the productivity in the non-tradable sector.
The coefficient in front of the productivity in the non-tradable sector (+0.20) is
significant, although it does not have the theoretically justified negative sign (i.e. it is
presumed that a rise in the productivity in this sector should lead to the depreciation of
the Bulgarian lev).

Moreover, the coefficient in front of productivity in the tradable sector does not
explain the fact that the non-tradable sector is more labor intensive. The latter is evident
in the ratio of relative labor share in the production of respectively, the non-tradable and
λ

tradable sector (----) which is above 1 and implies that there are more labor expenses in

λT

the non-tradable sector (see. Figure 9). On one side, this is due to the relatively higher
number of employees in the sector and to the services wage convergence to the wage
level in industry. On the other side, the level and growth rate of the services gross output
is lower than those of industry.

²⁷ The ratio PNT/PT is often interpreted as "internal real exchange rate" while the external real
exchange rate is calculated by deflating the nominal exchange rate by different price indices in the
country and of the major trade partners.

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