Does high M4 money growth trigger large increases in UK inflation? Evidence from a regime-switching model
AbstractMarch 2007 saw an increase of 3.1 percent in the Consumer Price Index (CPI) annual inflation rate and triggered the first explanatory letter from the Governor of the Bank of England to the Chancellor of the Exchequer since the Bank of England was granted operational independence in May 1997. The letter gave rise to a lively debate on whether policymakers should pay attention to the link between inflation and M4 money growth. Using UK data since the introduction of inflation targeting in October 1992, we show that: (i)~the relationship between inflation and M4 growth is not stable over time, and (ii)~the tendency of M4 to exert inflationary pressures is conditional on annual M4 growth exceeding 10\%. Above this threshold, a 1 percentage point increase in the annual growth rate of M4 increases annual inflation by only 0.09 percentage points, whereas a 1 percentage point increase in the disequilibrium between money and its long-run determinants increases annual inflation by only 0.07 percentage points. Since the money effects are very small, the implication is that the Monetary Policy Committee should not be particularly worried for not paying close attention to M4 money movements when setting interest rates.
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Bibliographic InfoPaper provided by Centre for Economic Research, Keele University in its series Keele Economics Research Papers with number KERP 2007/07.
Length: 19 pages
Date of creation: Jun 2007
Date of revision:
Note: I have benefited from the exchange of ideas with Tim Congdon and Chris Martin. Any remaining errors are mine.
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Postal: Centre for Economic Research, Research Institute for Public Policy and Management, Keele University, Staffordshire ST5 5BG - United Kingdom
Other versions of this item:
- Costas Milas, 2009. "Does high M4 money growth trigger large increases in UK inflation? Evidence from a regime-switching model," Oxford Economic Papers, Oxford University Press, vol. 61(1), pages 168-182, January.
- Costas Milas, 2007. "Does high M4 money growth trigger large increases in UK inflation? Evidence from a regime-switching model," Working Paper Series 25-07, The Rimini Centre for Economic Analysis, revised Jul 2007.
- C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation
- C52 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Evaluation, Validation, and Selection
- E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
- E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
This paper has been announced in the following NEP Reports:
- NEP-ALL-2007-08-08 (All new papers)
- NEP-CBA-2007-08-08 (Central Banking)
- NEP-MAC-2007-08-08 (Macroeconomics)
- NEP-MON-2007-08-08 (Monetary Economics)
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