Working Paper

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

Author

  • Kai Carstensen
Publication Date

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.

Info

JEL Classification
E47, E58

Key Words

  • core money growth
  • filter
  • forecasting
  • stability