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The P-star approach to the link between money and prices

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  • John A. Tatom

Abstract

This paper examines several specification errors in the M2-based P* model and develops an M1-based estimate of this model. The apparent statistical significance of M2 is shown to arise from a spurious regression that uses a non-stationary regressor and because the significance test for M2 is biased by including the influence of a lagged dependent variable whose coefficient is not normally distributed. When these problems are addressed, M2 is not statistically significant related to the price level. The M1-based P* model exhibits a significant relationship between M1 and the price level, however.

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Bibliographic Info

Paper provided by Federal Reserve Bank of St. Louis in its series Working Papers with number 1990-008.

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Date of creation: 1990
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Handle: RePEc:fip:fedlwp:1990-008

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Keywords: Inflation (Finance) ; Prices ; Money supply;

References

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  1. Perron, P., 1989. "Testing For A Unit Root In A Time Series With A Changing Mean," Papers 347, Princeton, Department of Economics - Econometric Research Program.
  2. R.A. Pecchenino & Robert H. Rasche, 1990. "P* Type Models: Evaluation and Forecasts," NBER Working Papers 3406, National Bureau of Economic Research, Inc.
  3. Francis X. Diebold & Glenn D. Rudebusch, 1990. "On the power of Dickey-Fuller tests against fractional alternatives," Finance and Economics Discussion Series 119, Board of Governors of the Federal Reserve System (U.S.).
  4. W. Michael Cox & Joseph H. Haslag, 1989. "The effects of financial deregulation on inflation, velocity growth, and monetary targeting," Research Paper 8907, Federal Reserve Bank of Dallas.
  5. John A. Tatom, 1990. "The effects of financial innovations on checkable deposits, M1 and M2," Review, Federal Reserve Bank of St. Louis, issue Jul, pages 37-57.
  6. John B. Carlson, 1989. "The indicator P-star: just what does it indicate?," Economic Commentary, Federal Reserve Bank of Cleveland, issue Sep.
  7. Stockton, David J & Glassman, James E, 1987. "An Evaluation of the Forecast Performance of Alternative Models of Inflation," The Review of Economics and Statistics, MIT Press, vol. 69(1), pages 108-17, February.
  8. Thomas M. Humphrey, 1989. "Precursors of the P-star model," Economic Review, Federal Reserve Bank of Richmond, issue Jul, pages 3-9.
  9. Davidson, Russell & MacKinnon, James G, 1981. "Several Tests for Model Specification in the Presence of Alternative Hypotheses," Econometrica, Econometric Society, vol. 49(3), pages 781-93, May.
  10. Brunner, Karl & Meltzer, Allan H., 1987. "Empirical studies of velocity, real exchange rates, unemployment, and productivity," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 27(1), pages 1-8, January.
  11. Granger, C. W. J. & Newbold, P., 1974. "Spurious regressions in econometrics," Journal of Econometrics, Elsevier, vol. 2(2), pages 111-120, July.
  12. Jeffrey J. Hallman & Richard D. Porter & David H. Small, 1989. "M2 per unit of potential GNP as an anchor for the price level," Staff Studies 157, Board of Governors of the Federal Reserve System (U.S.).
  13. Schwert, G. William, 1987. "Effects of model specification on tests for unit roots in macroeconomic data," Journal of Monetary Economics, Elsevier, vol. 20(1), pages 73-103, July.
  14. Yash P. Mehra, 1988. "The forecast performance of alternative models of inflation," Economic Review, Federal Reserve Bank of Richmond, issue Sep, pages 10-18.
  15. Kenneth N. Kuttner, 1990. "Inflation and the growth rate of money," Economic Perspectives, Federal Reserve Bank of Chicago, issue Jan, pages 2-11.
  16. Joseph H. Haslag, 1990. "Monetary aggregates and the rate of inflation," Economic and Financial Policy Review, Federal Reserve Bank of Dallas, issue Mar, pages 1-12.
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Cited by:
  1. Antonin Rusek, 2008. "Inflation Dynamics in New EU Member States: The Czech Case," International Advances in Economic Research, Springer, vol. 14(2), pages 191-204, May.
  2. Aurelijus Dabušinskas, 2005. "Money and Prices in Estonia," Bank of Estonia Working Papers 2005-07, Bank of Estonia, revised 10 Nov 2005.
  3. Frait, J. & Komarek, L. & Kulhanek, L., 2000. "P-Star-Model Based Analysis of Inflation Dynamic in the Czech Republic," The Warwick Economics Research Paper Series (TWERPS) 565, University of Warwick, Department of Economics.
  4. Mihalicova, Xenia & Gazda, Vladimír & Kubak, Matúš & Grof, Marek, 2011. "P-Star Model under the Currency Board – The Case of Bulgaria 1997-2008," Journal for Economic Forecasting, Institute for Economic Forecasting, vol. 0(3), pages 83-91, September.
  5. Karl-Heinz Tödter & Hans-Eggert Reimers, 1994. "P-Star as a link between money and prices in Germany," Review of World Economics (Weltwirtschaftliches Archiv), Springer, vol. 130(2), pages 273-289, June.
  6. Atta-Mensah, J, 1996. "A Modified P*-Model of Inflation Based on M1," Working Papers 96-15, Bank of Canada.

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