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Does high M4 money growth trigger large increases in UK inflation? Evidence from a regime-switching model

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  • Costas Milas

    () (Keele University, Centre for Economic Research and School of Economic and Management Studies)

Abstract

March 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.

Suggested Citation

  • Costas Milas, 2007. "Does high M4 money growth trigger large increases in UK inflation? Evidence from a regime-switching model," Keele Economics Research Papers KERP 2007/07, Centre for Economic Research, Keele University.
  • Handle: RePEc:kee:kerpuk:2007/07
    Note: I have benefited from the exchange of ideas with Tim Congdon and Chris Martin. Any remaining errors are mine.
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    File URL: http://www.keele.ac.uk/depts/ec/wpapers/kerp0707.pdf
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    References listed on IDEAS

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    Cited by:

    1. Christopher Martin & Costas Milas, 2009. "Causes of the Financial Crisis: an Assessment Using UK Data," Working Paper series 10_09, Rimini Centre for Economic Analysis.
    2. Valadkhani, Abbas, 2014. "Switching impacts of the output gap on inflation: Evidence from Canada, the UK and the US," International Review of Economics & Finance, Elsevier, vol. 33(C), pages 270-285.
    3. Abbas Valadkhani, 2015. "Asymmetric size-dependent effects of the output gap on inflation: US evidence from the last half a century," Applied Economics, Taylor & Francis Journals, vol. 47(33), pages 3525-3539, July.
    4. repec:eid:wpaper:18/09 is not listed on IDEAS
    5. Christopher Martin & Costas Milas, 2010. "Financial Market Liquidity and the Financial Crisis: An Assessment Using UK Data," International Finance, Wiley Blackwell, vol. 13(3), pages 443-459, Winter.
    6. Michael Ellington & Costas Milas, 2014. "Global liquidity, money growth and UK inflation," Working Paper series 21_14, Rimini Centre for Economic Analysis.

    More about this item

    Keywords

    M4; Money growth; Regime-switching models; UK inflation;

    JEL classification:

    • 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

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