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Is core money growth a good and stable inflation predictor in the euro area?

  • Kai Carstensen

In this paper, it is analyzed whether core money growth helps to predict future inflation in a useful and reliable way. Using an out-of-sample forecasting exercise and a stability analysis, it is shown that core money growth carries important information not contained in the inflation history, that its inclusion in a forecasting model can increase the forecasting accuracy, and that it has had a strong and stable long-run link to inflation over the last decades. A particularly promising forecasting model at all horizons is the one proposed by Gerlach (2004) that includes the inflation gap, the difference between core money growth and core inflation, and the output gap. This model has a very good track record, exhibits stable parameters over both the pre-EMU and the EMU era. What makes it appealing from a more theoretical perspective is that it relies on the stable long-run relationship between money growth and inflation.

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File URL: https://www.ifw-members.ifw-kiel.de/publications/is-core-money-growth-a-good-and-stable-inflation-predictor-in-the-euro-area-1/kap1318.pdf
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Paper provided by Kiel Institute for the World Economy in its series Kiel Working Papers with number 1318.

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Length: 39 pages
Date of creation: Feb 2007
Date of revision:
Handle: RePEc:kie:kieliw:1318
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  1. Warne, Anders & Bruggeman, Annick & Donati, Paola, 2003. "Is the demand for euro area M3 stable?," Working Paper Series 0255, European Central Bank.
  2. James H. Stock & Mark W. Watson, 1999. "Forecasting Inflation," NBER Working Papers 7023, National Bureau of Economic Research, Inc.
  3. Lemke, Wolfgang & Greiber, Claus, 2005. "Money demand and macroeconomic uncertainty," Discussion Paper Series 1: Economic Studies 2005,26, Deutsche Bundesbank, Research Centre.
  4. Timothy Cogley, 1998. "A simple adaptive measure of core inflation," Working Papers in Applied Economic Theory 98-06, Federal Reserve Bank of San Francisco.
  5. Assenmacher-Wesche, Katrin & Gerlach, Stefan, 2006. "Interpreting Euro Area Inflation at High and Low Frequencies," CEPR Discussion Papers 5632, C.E.P.R. Discussion Papers.
  6. Giacomini, Raffaella & Rossi, Barbara, 2006. "Detecting and predicting forecast breakdowns," Working Paper Series 0638, European Central Bank.
  7. Athanasios Orphanides & Simon van Norden, 1999. "The reliability of output gap estimates in real time," Finance and Economics Discussion Series 1999-38, Board of Governors of the Federal Reserve System (U.S.).
  8. Sylvia Kaufmann & Peter Kugler, 2005. "Does Money Matter for Inflation in the Euro Area?," Working Papers 103, Oesterreichische Nationalbank (Austrian Central Bank).
  9. Diebold, Francis X & Mariano, Roberto S, 2002. "Comparing Predictive Accuracy," Journal of Business & Economic Statistics, American Statistical Association, vol. 20(1), pages 134-44, January.
  10. Klaus Masuch & Sergio Nicoletti-Altimari & Massimo Rostagno & Huw Pill, 2003. "The role of money in monetary policymaking," BIS Papers chapters, in: Bank for International Settlements (ed.), Monetary policy in a changing environment, volume 19, pages 158-191 Bank for International Settlements.
  11. Carstensen, Kai, 2006. "Stock market downswing and the stability of European monetary union money demand," Munich Reprints in Economics 19940, University of Munich, Department of Economics.
  12. Nelson, Edward, 2003. "The future of monetary aggregates in monetary policy analysis," Journal of Monetary Economics, Elsevier, vol. 50(5), pages 1029-1059, July.
  13. Assenmacher-Wesche, Katrin & Gerlach, Stefan, 2006. "Understanding the Link between Money Growth and Inflation in the Euro Area," CEPR Discussion Papers 5683, C.E.P.R. Discussion Papers.
  14. Neumann, Manfred J. M. & Greiber, Claus, 2004. "Inflation and core money growth in the euro area," Discussion Paper Series 1: Economic Studies 2004,36, Deutsche Bundesbank, Research Centre.
  15. Henrik Hansen & Søren Johansen, 1999. "Some tests for parameter constancy in cointegrated VAR-models," Econometrics Journal, Royal Economic Society, vol. 2(2), pages 306-333.
  16. Woodford, Michael, 2007. "How Important is Money in the Conduct of Monetary Policy?," CEPR Discussion Papers 6211, C.E.P.R. Discussion Papers.
  17. Hansen, Bruce E, 1992. "Tests for Parameter Instability in Regressions with I(1) Processes," Journal of Business & Economic Statistics, American Statistical Association, vol. 10(3), pages 321-35, July.
  18. Gerlach, Stefan, 2003. "The ECB's Two Pillars," CEPR Discussion Papers 3689, C.E.P.R. Discussion Papers.
  19. George T. McCandless, Jr. & Warren E. Weber, 1995. "Some monetary facts," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Sum, pages 2-11.
  20. Engle, Robert F & Granger, Clive W J, 1987. "Co-integration and Error Correction: Representation, Estimation, and Testing," Econometrica, Econometric Society, vol. 55(2), pages 251-76, March.
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