This paper studies the relationship between inflation, output, money and interest rates in the euro area, using data spanning 1980 2000. The P* model is shown to have considerable empirical support. Thus, the price gap' or, equivalently, the real money gap' (the gap between current real balances and long-run equilibrium real balances), has substantial predictive power for future inflation. The real money gap contains more information about future inflation than the output gap and the Eurosystem's money-growth indicator (the gap between current M3 growth and a reference value). The results suggest that the Eurosystem's money-growth indicator is an inferior indicator of future inflation.
*Published:
Gerlach, Stefan and Lars E. O. Svensson. "Money And Inflation In The Euro Area: A Case For Monetary Indicators?," Journal of Monetary Economics, 2003, v50(8,Nov), 1649-1672.
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