Inflation Dynamics and Dual Inflation in Accession Countries: A 'New Keynesian' Perspective

Abstract

This paper examines inflation dynamics in the current EU-accession countries in central and eastern Europe, focusing particularly on the determinants of "dual inflation", that is, diverging inflation rates for tradable and non-tradable goods. The paper draws on the recently published data for the Harmonised Index of Consumer Prices (HICP) of the accession countries and, indeed, finds evidence of "dual inflation" in these economies. To test empirically for underlying determinants, the paper borrows from the recently developed New Phillips curve literature. Overall, domestic factors have systematically a stronger impact upon non-tradable goods inflation whereas international factors have a stronger impact over tradable goods inflation. Furthermore, the results point to the possibly very different effects of exchange rate regimes over tradable and non-tradable goods inflation. On the whole, the findings suggest that the Balassa-Samuelson effect is not a prominent factor behind the current experience of "dual inflation" in these countries.

Keywords: Dual Inflation, Central and Eastern European Countries, Balassa-Samuelson Effect, New Keynesian Phillips Curve, Exchange Rate Regimes

JEL Classification: E31, E58, F41, P24