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Inflation and core money growth in the euro area

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This paper studies the importance of money for inflation in the euro area. An inflation equation is derived from a small model that combines the supply and demand for money with a Phillips curve and the assumption that inflation expectations develop adaptively. The model's solution attributes an impact on inflation not to actual money growth but to its core component. The core component is defined as the long-lasting, low-frequency component of nominal money growth in excess of real money demand. Using quarterly euro area data from the 1980-2004 period we apply different filters (Hodrick-Prescott, Baxter-King, wavelets) as empirical measures of core money. The estimation results uniformly indicate that inflation and core money growth are closely linked, exhibiting a one-to-one relationship in the long-run. Higher-frequency money growth, in contrast, contributes nil to the explanation of actual inflation. As a stylised fact regarding frequency domain properties, cycles of money growth below eight years are found to be insignificant for inflation.

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Manfred J. M. Neumann, Claus Greiber

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Adapt according to the presented license agreement and reference the original author.