Inflation in the New EU Countries from Central and Eastern Europe : Theories and panel data estimations

This paper seeks to identify factors driving consumer price inflation in the new EU member countries from Central and Eastern Europe. Different theories are discussed, including some of particular importance to economies experiencing high economic growth and rapid structural change. The explanatory power of the theories is tested using panel data estimations based on annual data from 1997 to 2007. Convergence- related factors, including the Balassa-Samuelson and the Bhagwati capital-deepening effects, are important drivers of inflation. Import inflation and, by implication, exchange rate developments have an important impact, while the exchange rate regime is unimportant. Higher government debt and larger revenues are associated with higher inflation. The cyclical position as measured by unemployment, employment changes or the current account balance is found to affect inflation. Food price shocks have large but short-lived effects, while energy price shocks have longer-lasting effects on the inflation rate. Multicollinearity across the explanatory variables makes it difficult to identify the effect of each individual factor