Kiel Working Papers, Kiel Institute for World Economics
No 1318:
Is core money growth a good and stable inflation predictor in the euro area?
Kai Carstensen
Abstract: 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.
Keywords: Forecasting, core money growth, stability, filter; (follow links to similar papers)
JEL-Codes: E47,; E58; (follow links to similar papers)
39 pages, February 2007
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