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A Vector Autoregression Analysis of Bulgarian Inflation

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Abstract

This paper presents a vector autoregression analysis of the determinants of Bulgarian inflation over the period from 1991to2000. Monthly data are available for the entire period and various combinations of money aggregates, interest rates and the exchange rate were considered in modeling the dynamics of inflation in the Bulgarian economy. Bulgarian inflation is shown to have undergone two radically different regimes over the past decade. The dividing point between the two is the spring of 1997 when the hyperinflationary trends of the prior period were ended by the institution of a currency board. Inflation during the prior period is determined predominantly by monetary growth and to some extent by past inflation. Inflation after the institution of the currency board is no longer as dependent on monetary growth, while impulse response functions for the latter period clearly show the negative response of monetary authorities to price increases. In contrast, impulse response functions for the pre-currency board period demonstrate the explosive nature of the inflationary process, as monetary shocks cause the price level to grow without bound.

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WP 2000-13 October 2000

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This work was funded by USAID under its CAER II Project.

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2000-10

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Charles H. Dyson School of Applied Economics and Management, Cornell University

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