William Davidson Institute Working Paper 487
monetary conditions in Bulgaria and in the euro area. Under the CB, it is logical that
there are no conditions for a long-term deviation of the monetary conditions in the
Bulgarian economy from the ones in the euro area10. In other words, there are no long-
term monetary sources of inflation in the Bulgarian economy as far as there are no such
factors in the euro area.
However, the existence of a common monetary policy within the asymmetric
monetary union does not preclude the possibility of occurrence of an inflation differential
within this union. Although there is a common monetary policy (and we could also say a
common currency, as the irreversible pegging of the exchange rate reduces exchange rate
risk11 dramatically) a number of microeconomic and structural differences remain. We
could mention some like the difference in the degree of development of the economies, in
the economic and industry structure, in the rates of growth, the structure of corporate
governance, government tax policy, customs duties and expenditures12, the structure of
goods and labor market etc.
The flexibility of the labor market is of particular interest in its relation to price
dynamics and monetary regime stability: ways of setting salaries, flexibility of the
general level and of relative real salaries, flexibility of employment contracts, working
time flexibility, mobility of labor, etc.13. In a recent research comparison of the rigidity
indices of real wages between Bulgaria and several developed countries the figures prove
that the Bulgarian labor market is more rigid than the EU one, although certain
10 Of course, short-term disproportions could exist between money supply and demand, due to a shock
(innovation) in the money supply. In this case, economic agents are turning their real money stocks to the
ones they would like to have after a certain lag. In annex 1 we discuss a model where temporary
disproportions between money supply and demand are related to the non-tradable goods sector.
11 It could be questioned here the argument that the pegging of the exchange rate at the time of
introduction of the currency board eliminates exchange rate risk, as the level of pegging may be changed
by the country’s Parliament (Nenovsky and al., 2002). In establishing the monetary union, exchange rates
are irrevocably fixed. For a discussion on this subject, see Berg and Borensztein (2000).
12 Komulainen and Pirttila (2000) apply the fiscal theory approach to inflation in transition economies
including Bulgaria.
13 See Soltwedel and al., 1999. Real wages are considered to be more flexible where unemployment
exerts a strong pressure on “equilibrium” salaries (Berthold and al., 1999).