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Does Money Matter for Inflation in the Euro Area?

Author

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  • Kaufmann, Sylvia
  • Kugler, Peter

    () (University of Basel)

Abstract

We analyse the role of euro area M3 as an indicator for future inflation. We analyse the short and long run relationship between money growth and inflation in an error correction framework taking into account the output gap and short and long term interest rates. We find robust cointegration between money growth and inflation. In the long run, shocks in M3-growth account for 33 percent to 40 percent of the inflation forecast error variance. We find evidence for significantly different dynamics of interest rates at the end of the seventies and beginning of the eighties. The dynamic relationship between money growth and inflation, however, remains stable over time, which implies that the deviation of real money growth from its long run average is a good indicator for future inflation acceleration or deceleration. Of course, this finding confirms the usefulness of monetary analysis in the ECB policy setting process and indicates that an M3-growth rate of slightly above 5% is compatible with a nonaccelerating average rate of inflation of 2%.

Suggested Citation

  • Kaufmann, Sylvia & Kugler, Peter, 2005. "Does Money Matter for Inflation in the Euro Area?," Working papers 2005/09, Faculty of Business and Economics - University of Basel.
  • Handle: RePEc:bsl:wpaper:2005/09
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    References listed on IDEAS

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    Cited by:

    1. Kaufmann, Sylvia & Kugler, Peter, 2005. "Expected Money Growth, Markov Trends and the Instability of Money Demand in the Euro Area," Working papers 2005/07, Faculty of Business and Economics - University of Basel.
    2. Woodford, Michael, 2007. "Does a 'Two-Pillar Phillips Curve' Justify a Two-Pillar Monetary Policy Strategy?," CEPR Discussion Papers 6447, C.E.P.R. Discussion Papers.
    3. De Santis, Roberto A. & Favero, Carlo A. & Roffia, Barbara, 2013. "Euro area money demand and international portfolio allocation: A contribution to assessing risks to price stability," Journal of International Money and Finance, Elsevier, vol. 32(C), pages 377-404.
    4. Benchimol, Jonathan & Fourçans, André, 2012. "Money and risk in a DSGE framework: A Bayesian application to the Eurozone," Journal of Macroeconomics, Elsevier, vol. 34(1), pages 95-111.
    5. Michael Woodford, 2008. "How Important Is Money in the Conduct of Monetary Policy?," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 40(8), pages 1561-1598, December.
    6. Gomez-Biscarri, Javier & Hualde, Javier, 2015. "A residual-based ADF test for stationary cointegration in I(2) settings," Journal of Econometrics, Elsevier, vol. 184(2), pages 280-294.
    7. Hofmann, Boris, 2009. "Do monetary indicators lead euro area inflation?," Journal of International Money and Finance, Elsevier, vol. 28(7), pages 1165-1181, November.
    8. Gebhard Kirchgässner & Jürgen Wolters, 2010. "The Role of Monetary Aggregates in the Policy Analysis of the Swiss National Bank," Swiss Journal of Economics and Statistics (SJES), Swiss Society of Economics and Statistics (SSES), vol. 146(I), pages 221-253, March.
    9. Emil Stavrev & Helge Berger, 2012. "The information content of money in forecasting euro area inflation," Applied Economics, Taylor & Francis Journals, vol. 44(31), pages 4055-4072, November.
    10. Assenmacher-Wesche, Katrin & Gerlach, Stefan, 2008. "Interpreting euro area inflation at high and low frequencies," European Economic Review, Elsevier, vol. 52(6), pages 964-986, August.
    11. Jonas Stulz, 2007. "Exchange rate pass-through in Switzerland: Evidence from vector autoregressions," Economic Studies 2007-04, Swiss National Bank.
    12. Sylvia Kaufmann & Peter Kugler, 2010. "A monetary real-time conditional forecast of euro area inflation," Journal of Forecasting, John Wiley & Sons, Ltd., vol. 29(4), pages 388-405.
    13. Gianni Amisano & Roberta Colavecchio, 2013. "Money Growth and Inflation: evidence from a Markov Switching Bayesian VAR," Macroeconomics and Finance Series 201304, Hamburg University, Department Wirtschaft und Politik.
    14. Sylvia Kaufmann & Maria Teresa Valderrama, 2010. "The Role Of Credit Aggregates And Asset Prices In The Transmission Mechanism: A Comparison Between The Euro Area And The Usa," Manchester School, University of Manchester, vol. 78(4), pages 345-377, July.
    15. Kulaksizoglu, Tamer & Kulaksizoglu, Sebnem, 2009. "The U.S. Excess Money Growth and Inflation Relation in the Long-Run: A Nonlinear Analysis," MPRA Paper 23780, University Library of Munich, Germany.
    16. Dreger, Christian & Wolters, Jürgen, 2014. "Money demand and the role of monetary indicators in forecasting euro area inflation," International Journal of Forecasting, Elsevier, vol. 30(2), pages 303-312.
    17. El-Shagi, Makram & Giesen, Sebastian, 2010. "Money and Inflation: The Role of Persistent Velocity Movements," IWH Discussion Papers 2/2010, Halle Institute for Economic Research (IWH).
    18. Egorov D.A. & Perevyshina E.A., 2016. "Modelling of Inflationary Processes in Russia," Working Papers 2138, Russian Presidential Academy of National Economy and Public Administration.
    19. El-Shagi, Makram & Giesen, Sebastian & Kelly, Logan J., 2015. "The Quantity Theory Revisited: A New Structural Approach," Macroeconomic Dynamics, Cambridge University Press, vol. 19(01), pages 58-78, January.
    20. El-Shagi, Makram & Giesen, Sebastian, 2013. "Money and inflation: Consequences of the recent monetary policy," Journal of Policy Modeling, Elsevier, vol. 35(4), pages 520-537.

    More about this item

    JEL classification:

    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E41 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Demand for Money

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