ARE MONEY AGGREGATES GOOD PREDICTORS FOR THE BULGARIAN INFLATION RATE?

Abstract

The purpose of this article is to study the relationship between the increase of the money stock and the increase of the price level in the Bulgarian economy through the implementation of a monetarist price gap model and through the study of VAR forecasting performances. Firstly, we obtain that the price gap, namely the difference between the theoretical sustainable price level as defined using the equation of exchange and the observed price level is a relevant predictor for inflation dynamics in Bulgaria. Secondly, the analysis of the performance of VAR forecasts of inflation show that the M2 money supply is a fundamental variable present in the best forecasting models, evaluated through their predictive accuracy, when tested on the recent inflationary upswing which began in the third quarter of 2021. This finding is especially important for Bulgaria, given that its monetary policies are bonded to those of the European Central Bank (ECB) through its local currency board. The ECB’s expansionist monetary policy in the wake of the COVID-19 pandemic can thus be seen as one of the factors explaining the unusually high inflation level in Bulgaria.