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Long Run Evidence on Money Growth and Inflation

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Author Info
Luca Benati () (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.)
Abstract

Over the last two centuries, the cross-spectral coherence between either narrow or broad money growth and inflation at the frequency ω=0 has exhibited little variation–being, most of the time, close to one–in the U.S., the U.K., and several other countries, thus implying that the fraction of inflation’s long-run variation explained by long-run money growth has been very high and relatively stable. The cross-spectral gain at ω=0, on the other hand, has exhibited significant changes, being for long periods of time smaller than one. The unitary gain associated with the quantity theory of money appeared in correspondence with the inflationary outbursts associated with World War I and the Great Inflation–but not World War II–whereas following the disinflation of the early 1980s the gain dropped below one for all the countries and all the monetary aggregates I consider, with one single exception. I propose an interpretation for this pattern of variation based on the combination of systematic velocity shocks and infrequent inflationary outbursts. Based on estimated DSGE models, I show that velocity shocks cause, ceteris paribus, comparatively much larger decreases in the gain between money growth and inflation at ω=0 than in the coherence, thus implying that monetary regimes characterised by low and stable inflation exhibit a low gain, but a still comparatively high coherence. Infrequent inflationary outbursts, on the other hand, boost both the gain and coherence towards one, thus temporarily revealing the one-for-one correlation between money growth and inflation associated with the quantity theory of money, which would otherwise remain hidden in the data. JEL Classification: E30, E32.

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Paper provided by European Central Bank in its series Working Paper Series with number 1027.

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Length: 83 pages
Date of creation: Mar 2009
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Handle: RePEc:ecb:ecbwps:20091027

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Related research
Keywords: Quantity theory of money; inflation; frequency domain; cross-spectral analysis; band-pass filtering; DSGE models; Bayesian estimation; trend inflation.;

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  7. Luca Benati, 2008. "Investigating Inflation Persistence Across Monetary Regimes," The Quarterly Journal of Economics, MIT Press, vol. 123(3), pages 1005-1060, August. [Downloadable!] (restricted)
  8. Richard Clarida & Jordi Galí & Mark Gertler, 2000. "Monetary Policy Rules And Macroeconomic Stability: Evidence And Some Theory," The Quarterly Journal of Economics, MIT Press, vol. 115(1), pages 147-180, February. [Downloadable!] (restricted)
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  9. Sargent, Thomas & Surico, Paolo, 2008. "Monetary policies and low-frequency manifestations of the quantity theory," Discussion Papers 26, Monetary Policy Committee Unit, Bank of England. [Downloadable!]
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  20. Luca Benati, 2008. "Investigating inflation persistence across monetary regimes," Working Paper Series 851, European Central Bank. [Downloadable!]
  21. Thomas A. Lubik & Frank Schorfheide, 2004. "Testing for Indeterminacy: An Application to U.S. Monetary Policy," American Economic Review, American Economic Association, vol. 94(1), pages 190-217, March. [Downloadable!]
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  1. Jens Eisenschmidt & Astrid Hirsch & Tobias Linzert, 2009. "Bidding behaviour in the ECB's main refinancing operations during the financial crisis," Working Paper Series 1052, European Central Bank. [Downloadable!]
  2. Thomas Y. Mathä & Olivier Pierrard, 2009. "Search in the Product Market and the Real Business Cycle," Working Paper Series 1036, European Central Bank. [Downloadable!]
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  3. Luca Agnello & Ricardo M. Sousa, 2009. "The determinants of public deficit volatility," Working Paper Series 1042, European Central Bank. [Downloadable!]
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  4. Matthieu Darracq Pariès & Stéphane Moyen, 2009. "Monetary Policy and Inflationary Shocks Under Imperfect Credibility," Working Paper Series 1065, European Central Bank. [Downloadable!]
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