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



William Davidson Institute Working Paper 487

methodology of BS measurement. Section 3 presents the results of the empirical tests,
and in the
final section we will make some conclusions about the economic policy in
Bulgaria and draw directions of future theoretical and empirical studies.

II.    Sources of inflation under the CB

1.     Theoretical grounds

Altogether the sources and dynamics of inflation in transition countries have been
studied over and over in a long period of time focusing on different approaches:
monetary-fiscal explanation of inflation (Dornbusch, 1991), structural explanation
concerning the process of transition (Commander and Coricelli, 1991, Bauer, 1991,
Blanchard and al., 1995), struggle between groups of different interests (Olson, 2000),
purely fiscal explanation in the spirit of the fiscal theory of price level (Komulainen and
Pirttila, 2000), dual or productivity-generated inflation (Arratibel and al., 2001,
Dobrinsky, 2000, Pelkmans and al., 2000, Egert, 2002, Backe and al., 2002), structural
synthesised model including the pass-through effect (Nenovsky and al., 2000, Darvas,
2001) among others6.

Nevertheless there are not many studies on inflation in transition countries under
the CB arrangement and especially for Bulgaria7. Usually such analyses concentrate on
the real sources of inflation expressed in the BS effect or pass-through effects. When
inflation under the CB is studied, several questions should be concerned. The first
question is whether and what kind of
monetary sources of inflation exist. If there is
monetary generated inflation, then what part of it is natural and what is caused by the
deliberate or unconscious activities of the monetary authorities (in spite of the imposed
constraints by the CB)? It is logically assumed that the natural levels of inflation can be
bound to the temporary disequilibria of money supply and demand, which are connected

6 In the last 2-3 years several research papers were written on the general convergence of Central
and Eastern European countries to the EU (see Brada and Kutan, 2001, Kocenda, 2001, Weimann,
2001, Kutan and Pautola-Mol, 2002 and Halpern and Nemenyi, 2002 among others).

7 For Estonia (Saarniit and al., 2000) and Lithuania - (BoL, 2000).



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