What determines inflation?

This paper focuses on the determinants of inflation for new European Union members during the period from 1996 to 2011. We utilise a structural vector error correction model to estimate mark–up or long–run output gap relationships and the analyse dynamic properties of the models. We find that Slovakia, the Czech Republic, Hungary, Poland and Bulgaria can be characterised by cost–push inflation from a long–run perspective whereas demand–side factors are more characteristic for Slovenia, Estonia, Latvia, Lithuania and Romania. Inflation dynamics in short–run inflation were influenced by inertia, labour costs, foreign market competitiveness, production as well as some exogenous shocks. We also investigate the direct relationship between inflation and government deficit; however, there seems to be no interdependency between these variables in the long run.