William Davidson Institute Working Paper 487
I. Inflation on the long way to EU accession
The process of catching-up of the Bulgarian economy and of its nominal
convergence to the euro area is connected mainly with price level convergence of
accession countries. In general this implies higher inflation rates as well as relatively
quick adjustments in the structure of relative prices. However such dynamics faces a
conflict with a part of the formal membership criteria and with the choice of a hard
monetary regime like the currency board (CB) as well. The problems and respectively the
questions that emerge from the “triangle of inconsistency” (the CB, catching-up process
and Maastricht criteria) can be stated in the following way:
(i) Do catching-up processes lead to appreciation of the real exchange rate
(hence to low competitiveness of the Bulgarian export) especially when the nominal
exchange rate is extremely rigid (fixed by law)? Answering this question, we have to
study the impact of all aspects of the convergence process on the dynamics of the real
exchange rate in Bulgaria and see whether it is depreciated or appreciated taking into
account its possible initial depreciation before its pegging. And eventually, if the
exchange rate is appreciated, is the CB as a monetary regime compatible with the
“optimal” transition process? Furthermore, is the CB (providing price stability)
compatible with the catching-up process requiring price level increase?
(ii) And while the CB and Maastricht criteria are on the side of low inflation, is
it possible to comply with the nominal membership criteria (Maastricht criteria) and with
the catching-up process1 at the same time? This question tackles even the broader
theoretical aspect of convergence. Whether different long run equilibrium paths of price
levels and nominal interest rates exist for member and applicant countries or not? And if
they exist, every group would follow its own equilibrium trend (steady state). In spite of
the technology transfers and production factors flows, as stated by the neoclassical
growth theory different groups of countries converge to different levels of their
1 Art.121 of the Protocol and ECOFIN (2000). The problem was discussed recently by Buitter and
Grafe (2001) and Szapary (2001).