Inflation In 2007

Recently the data about the consumer price index for December 2007 were published and that made it possible to analyze its development throughout the year. The growth of the prices during December 2007 compared to December 2006 is 12.5%, while the average annual inflation during 2007 is 8.4%, which is the highest value since the year 2000.

The main reason for the prices growth is the change of the money supply. It is due to various factors but the basic one is the currency board. This is a monetary regime where the new emission of money by the central bank is done only when there is a cover by the reserve currency – EURO. Thus the initiative must come from a participant on the market, while the central bank must when requested to exchange levs against EURO and vice versa according to a fixed rate. One of the conditions for successful functioning of the board is to have complete coverage of the money base with currency reserves. In Bulgaria with currency reserves is also covered the deposit of the government with "Emissions" department, which is playing the role of the currency board. This allows sterilizing part of the capital flow, which enter the economy, where the fund are put into deposit and do not multiply. 

The strong positive balance of the financial account, which is greater than that of the current account, leads to increase in the official currency reserves and the money supply of the country.  Together with that, the internal credit and deposit base are also increased, which means that more money is created than are in demand. The result is the increase of prices. Naturally this is not happening evenly, since the supply and demand of the various good and services also change.

An example of that are the food staff and the nonalcoholic beverages, which at the end of 2007 are with 21.1% higher prices than at the end of the previous year.  The causes could be both on the side of the demand and the supply side.  The higher incomes of the population, as a result of increased salaries and pensions, lead to higher demand, which on top of that is with low elasticity. On the other hand the weak harvest due to unfavorable climate conditions reduced the supply. 

Another group where the prices have increased significantly is the services in restaurants and hotels (increase by 19.3%), as well as the transportation services (15%). We can expect in the middle term that the prices for services will grow faster than those of goods, since there the difference from the average levels in the European Union is significantly larger.  While the prices of some goods are closer to those in the EU (for some other good they are already higher), with the services where the cost of labor is a higher percentage of the production costs and the end-user price, they are still significantly lower. Hence, the prices of services must grow with a higher rate during the next several years.

On the other hand the prices in the communication sector are falling slightly. The reason for that is the increased competition in mobile communications and suppliers of internet services, while in the postal services, the state monopoly is artificially maintained.

The competition on the supply side on some markets is still inefficient and this leads to higher prices. The government policy in that respect must be directed toward removal of the obstacles for entry of new players and reduction of the costs to comply with regulations. This is the way to increase production and competitiveness of the companies which operate in the country. The benefits of that will not only are for them, but for the consumers as well, which could have more goods and services.

The expectations for 2008 are related to continued growth of the money supply in the country, inflow of capitals and hence increasing prices. The average yearly inflation will probably be between 5 and 7%; here we exclude the possible unfavorable shocks like from the bad harvest as in 2007. The growth of the salaries and pensions will be faster than the growth of prices, but we should keep in mind that the fast growth of incomes increases the inflationary expectations and also leads to increase of the price levels.