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Money growth and inflation: A regime switching approach

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  • Amisano, Gianni
  • Fagan, Gabriel

Abstract

We develop a Markov Switching model for inflation with time-varying transition probabilities. Inflation is characterized by two regimes (high and low inflation) and the probability of regime changes depends on money growth. Using Bayesian techniques, we apply the model to the euro area, Germany, the US, the UK and Canada for data from the 1960s up to the present. Our estimates suggest that a smoothed measure of broad money growth, corrected for real-time estimates of trend velocity and potential output growth, has important leading indicator properties for switches between inflation regimes. Thus money growth provides an important early warning indicator for risks to price stability.

Suggested Citation

  • Amisano, Gianni & Fagan, Gabriel, 2013. "Money growth and inflation: A regime switching approach," Journal of International Money and Finance, Elsevier, vol. 33(C), pages 118-145.
  • Handle: RePEc:eee:jimfin:v:33:y:2013:i:c:p:118-145
    DOI: 10.1016/j.jimonfin.2012.09.006
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    More about this item

    Keywords

    Money growth; Inflation regimes; Early warning; Time varying transition probabilities; Markov Switching model; Bayesian inference;
    All these keywords.

    JEL classification:

    • C11 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Bayesian Analysis: General
    • C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Prediction Models; Simulation Methods
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation

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