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Money As An Inflation Indicator In Chile: Does P* Still Work?

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  • Tobias Broer
  • Rodrigo Caputo

Abstract

This paper analyses the information content of monetary aggregates for inflation in Chile. In particular, we adopt the P* framework that separates the effect of an estimated money overhang from those of the output gap. We use two variants of the model, the original Hallman et al (1991), and Gerlach and Svensson (2003), that conditions on an inflation target. We estimate both models for 6 different monetary aggregates, and 2 alternative estimates of equilibrium velocity. We find that over the estimation period, deviations of velocity from its equilibrium have significant effects on inflation, across models and definitions of the money gap, and for both narrow and broad money. The usual Chilean aggregate M1A, although it has some indicator properties, is outperformed by other money aggregates, first of all cash in the hands of the public, and a broad money aggregate containing time and foreign currency deposits. However, out-of sample forecasts show that over the recent past, most money gaps do not improve inflation forecasts. Also, inflation forecasts from broad and narrow money aggregates diverge in opposite directions in recent years, reflecting the estimated gaps that are large both for M1A and broader definitions of money, but opposite in sign. This finding puts a question mark behind the stability of money demand in recent times of stable and low inflation.

Suggested Citation

  • Tobias Broer & Rodrigo Caputo, 2004. "Money As An Inflation Indicator In Chile: Does P* Still Work?," Working Papers Central Bank of Chile 293, Central Bank of Chile.
  • Handle: RePEc:chb:bcchwp:293
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    References listed on IDEAS

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    1. Lars E. O. Svensson, 2000. "Does the P* Model Provide Any Rationale for Monetary Targeting?," German Economic Review, Verein für Socialpolitik, vol. 1(1), pages 69-81, February.
    2. Hallman, Jeffrey J & Porter, Richard D & Small, David H, 1991. "Is the Price Level Tied to the M2 Monetary Aggregate in the Long Run?," American Economic Review, American Economic Association, vol. 81(4), pages 841-858, September.
    3. Gerlach, Stefan & Svensson, Lars E. O., 2003. "Money and inflation in the euro area: A case for monetary indicators?," Journal of Monetary Economics, Elsevier, vol. 50(8), pages 1649-1672, November.
    4. Peter C. B. Phillips & Mico Loretan, 1991. "Estimating Long-run Economic Equilibria," Review of Economic Studies, Oxford University Press, vol. 58(3), pages 407-436.
    5. McCallum, Bennett T, 1980. "Rational Expectations and Macroeconomic Stabilization Policy: An Overview," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 12(4), pages 716-746, November.
    6. Jorge Restrepo L., 2002. "Demanda de Dinero para Transacciones en Chile," Notas de Investigación Journal Economía Chilena (The Chilean Economy), Central Bank of Chile, vol. 5(3), pages 95-104, December.
    7. Mussa, Michael, 1981. "Sticky Prices and Disequilibrium Adjustment in a Rational Model of the Inflationary Process," American Economic Review, American Economic Association, vol. 71(5), pages 1020-1027, December.
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    Cited by:

    1. Jorge E. Restrepo & Andrea Tokman R., 2005. "Labor Markets and Institutions: An Overview," Central Banking, Analysis, and Economic Policies Book Series,in: Jorge Restrepo & Andrea Tokman R. & Norman Loayza (Series Editor) & Klaus Schmidt-Hebbel (Series Edi (ed.), Labor Markets and Institutions, edition 1, volume 8, chapter 1, pages 001-016 Central Bank of Chile.
    2. Rómulo A. Chumacero & Klaus Schmidt-Hebbel, 2005. "General Equilibrium Models: An Overview," Central Banking, Analysis, and Economic Policies Book Series,in: Rómulo A. Chumacero & Klaus Schmidt-Hebbel & Norman Loayza (Series Editor) & Klaus Schmidt-Hebbel (S (ed.), General Equilibrium Models for the Chilean Economy, edition 1, volume 9, chapter 1, pages 001-027 Central Bank of Chile.
    3. Huaita, Franklin, 2005. "Dinero como indicador de la inflación en Chile
      [Money as an inflation indicator in Chile]
      ," MPRA Paper 9943, University Library of Munich, Germany.
    4. Pamela Jervis, 2007. "Inflation Compensation and Its Components in Chile," Journal Economía Chilena (The Chilean Economy), Central Bank of Chile, vol. 10(2), pages 27-56, August.

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