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