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Money and Inflation: The Role of Persistent Velocity Movements

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  • El-Shagi, Makram
  • Giesen, Sebastian

Abstract

While the long run relation between money and inflation is well established, empirical evidence on the adjustment to the long run equilibrium is very heterogeneous. In the present paper we use a multivariate state space framework, that substantially expands the traditional vector error correction approach, to analyze the short run impact of money on prices. We contribute to the literature in three ways: First, we distinguish changes in velocity of money that are due to institutional developments and thus do not induce inflationary pressure, and changes that reflect transitory movements in money demand. This is achieved with a newly developed multivariate unobserved components decomposition. Second, we analyze whether the high volatility of the transmission from monetary pressure to inflation follows some structure, i.e., if the parameter regime can assumed to be constant. Finally, we use our model to illustrate the consequences of the monetary policy of the Fed that has been employed to mitigate the impact of the financial crisis, simulating different exit strategy scenarios.

Suggested Citation

  • 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).
  • Handle: RePEc:zbw:iwhdps:iwh-2-10
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    References listed on IDEAS

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    1. Orphanides, Athanasios & Porter, Richard D., 2000. "P revisited: money-based inflation forecasts with a changing equilibrium velocity," Journal of Economics and Business, Elsevier, vol. 52(1-2), pages 87-100.
    2. Benk, Szilárd & Gillman, Max & Kejak, Michal, 2010. "A banking explanation of the US velocity of money: 1919-2004," Journal of Economic Dynamics and Control, Elsevier, vol. 34(4), pages 765-779, April.
    3. Sylvia Kaufmann & Peter Kugler, 2008. "Does Money Matter For Inflation In The Euro Area?," Contemporary Economic Policy, Western Economic Association International, vol. 26(4), pages 590-606, October.
    4. 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.
    5. Christiano, Lawrence J. & Eichenbaum, Martin & Evans, Charles L., 1999. "Monetary policy shocks: What have we learned and to what end?," Handbook of Macroeconomics,in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 2, pages 65-148 Elsevier.
    6. Jürgen Wolters & Timo Teräsvirta & Helmut Lütkepohl, 1998. "Modeling The Demand For M3 In The Unified Germany," The Review of Economics and Statistics, MIT Press, vol. 80(3), pages 399-409, August.
    7. 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.
    8. Christian Dreger & Jürgen Wolters, 2009. "Money velocity and asset prices in the euro area," Empirica, Springer;Austrian Institute for Economic Research;Austrian Economic Association, vol. 36(1), pages 51-63, February.
    9. Helmut Herwartz & Hans-Eggert Reimers, 2006. "Long-Run Links among Money, Prices and Output: Worldwide Evidence," German Economic Review, Verein für Socialpolitik, vol. 7, pages 65-86, February.
    10. Durbin, James & Koopman, Siem Jan, 2012. "Time Series Analysis by State Space Methods," OUP Catalogue, Oxford University Press, edition 2, number 9780199641178.
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    Citations

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    Cited by:

    1. 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.
    2. Svatopluk Kapounek, 2011. "Monetary Policy Implementation in the Eurozone - the Concept of Endogenous Money," MENDELU Working Papers in Business and Economics 2011-12, Mendel University in Brno, Faculty of Business and Economics.

    More about this item

    Keywords

    multivariate state space model; inflation; money; Umlaufsgeschwindigkeit; multivariates Zustandsraummodell; Inflation; Geldmenge;

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • 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

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