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  • 10.12.2005

    Inflation Dynamics in the Transition Economy of Ukraine

    (Code:28)

    As many other transition economies of the Central and Eastern Europe (CEE), Ukraine passed through years of sharp economic decline, rising unemployment, and hyperinflation, which were followed by a period of relative macroeconomic stability. While there is some conformity among researchers regarding causes of high inflation in the economies passing through initial stage of deep economic transformation (see, for example, Ghosh, 1997; Fischer et al., 1996), the driving forces of price development during stabilization period vary from country to country. There is evidence that in some cases import prices is the only factor driving prices on other goods inside the country, while traditional monetary factor plays very limited role (results obtained by Kutan and Brada (1999) for the Czech Republic, Hungary, and Poland). In other economies money growth along with exchange rate movements play important role for inflation development (see Ross (2000) for Slovenia). Thus, depending on an institutional context peculiar to particular economy inflation can be driven by different factors.

    The purpose of this paper is to reveal which of the possible factors cause inflation development in Ukraine. We do this by exploring dynamic interrelationship between inflation and other macroeconomic indicators that may affect price dynamics. The choice of possible determinants grounds on analysis of macroeconomic relationships in the country. It shows us that apart from commonly investigated factors of inflation, such as money supply and wage growth, peoples expectations towards exchange rate may have strong influence on price growth in the Ukrainian economy. The role of expectations for determining inflation path is fully recognized in theoretical literature; however, attempts to verify it empirically is usually hindered by unavailability of data - the problem especially acute in transition economies. Here we tackle the data problem by using information available from foreign currency cash market for approximating expectations. Thus, to the best of our knowledge this paper will be a first attempt to investigate the influence of expectations on inflation dynamics in transition economies. Apart from deeper understanding of the inflationary process in Ukraine, the evidence provided here will help to figure out the role of monetary policy in managing inflation and, consequently, to draw some lessons as to the feasibility of inflation targeting regime in Ukraine.

    The paper proceeds as follows. In the next section we briefly summarize findings of previous research regarding determinants of inflation in transition economies. The economic development in Ukraine with some implications for econometric modeling is examined in Section 3. The data are described in Section 4. In Section 5 we explain the methodology and report the obtained results. The final section concludes.

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