Money Growth And Inflation: A Regime Switching Approach

Date Added: Jun 2010
Format: PDF

The authors develop time-varying transition probabilities Markov Switching model in which inflation is characterised by two regimes (high and low inflation). Using Bayesian techniques, they apply the model to the euro area, Germany, the US, the UK and Canada for data from the 1960s up to the present. The estimates suggest that a smoothed measure of broad money growth, corrected for real-time estimates of trend velocity and potential output growth has important leading indicator properties for switches between inflation regimes. Thus money growth provides an important early warning indicator for risks to price stability.