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The information content of M3 for future inflation

Author

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  • Trecroci, Carmine
  • Vega, Juan Luis

Abstract

The information content of broad money M3 for future GDP inflation in the euro area is investigated from a number of perspectives. Firstly, tests that money does not Granger-cause prices are conducted within a cointegrated VAR system comprising real M3 holdings, real GDP, inflation and short- and long-term interest rates. Secondly, this empirical framework is extended to investigate the claim that - in the context of an extended P-star model - the real money gap has substantial predictive power for future inflation. And thirdly, the P-star type of model developed is compared with an existing rival model of inflation in the euro area where no explicit role is given to monetary developments. Our empirical results confirm that a significant positive association exists between the real money gap and future inflation up to five to six quarters ahead, reaching a maximum at the three-to-four quarter horizon. It is also shown that, although the extended P-star model outperforms the competing model in terms of out-of-sample forecast accuracy (as measured by the root mean square forecast errors) at horizons above two quarters, the hypothesis that no useful information is contained in rival evidence can be rejected at standard confidence levels. JEL Classification: C32, C50, E30, E40

Suggested Citation

  • Trecroci, Carmine & Vega, Juan Luis, 2000. "The information content of M3 for future inflation," Working Paper Series 0033, European Central Bank.
  • Handle: RePEc:ecb:ecbwps:20000033
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    References listed on IDEAS

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    More about this item

    Keywords

    euro area; inflation; leading indicators; M3; monetary aggregates; P-star;

    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
    • C50 - Mathematical and Quantitative Methods - - Econometric Modeling - - - General
    • E30 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - General (includes Measurement and Data)
    • E40 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - General

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