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The information content of money in forecasting euro area inflation

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Abstract:

This article contributes to the debate on the role of money in monetary policy by analysing the information content of money in forecasting euro-area inflation. We compare the predictive performance within and among various classes of structural and empirical models in a consistent framework using Bayesian and other estimation techniques. We find that money contains relevant information for inflation in some model classes. Money-based New Keynesian Dynamic Stochastic General Equilibrium (DSGE) models and Vector Autoregressions (VARs) incorporating money perform better than their cashless counterparts. But there are also indications that the contribution of money has its limits. The marginal contribution of money to forecasting accuracy is often small, money adds little to dynamic factor models, and it worsens forecasting accuracy of partial equilibrium models. Finally, nonmonetary models dominate monetary models in an all-out horserace.

Keywords: C11; C30; E31; E40; information content of money; inflation forecasting; New Keynesian model; DSGE model; P* model; two-pillar Phillips curve; VAR model; general dynamic factor model; Bayesian estimation; euro area

Document Type: Research Article

DOI: http://dx.doi.org/10.1080/00036846.2011.587776

Affiliations: 1: Department of Economics,Free University of Berlin, Boltzmann Strasse 20Berlin 14195, Germany 2: IMF, Washington, USA

Publication date: November 1, 2012

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