A Note of Caution on the Relation Between Money Growth and Inflation

IMF Working Papers, June 30, 2023

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Canonical URL: A Note of Caution on the Relation Between Money Growth and Inflation

Authors: Helge Berger, Sune Karlsson, Pär Österholm
Date: June 30, 2023
Core finding: The bivariate relation between money growth and inflation in the euro area and the United States is statistically unstable over time when assessed with hybrid time-varying parameter Bayesian VAR models.
Abstracted conclusion: Cautions against asserting a simple, time-invariant relationship when modeling the joint dynamics of monetary aggregates and consumer prices.

Model framework: Hybrid time-varying parameter Bayesian VAR models.
Model selection criterion: Marginal likelihoods.
Regions studied: Euro area and the United States.
Series focus: Monetary aggregates (money growth) and consumer price inflation.
Keywords reported: Bayesian VAR, Euro area inflation, Inflation, inflation response, money growth, response of shock, Stochastic volatility, Time-varying parameters, trend inflation.

Statistical instability: Model selection based on marginal likelihoods suggests that the relation is statistically unstable across time in both regions.
Temporal pattern of effect:
- The effect of money growth on inflation weakened notably after the 1980s.
- The effect strengthened after 2020.
Relation to trend inflation: There is evidence that the time variation is related to the pace of price changes; the maximum impact of money growth on inflation is increasing in the trend level of inflation.

Modeling caution: Avoid asserting a simple, time-invariant relationship between monetary aggregates and consumer prices when specifying models for inflation dynamics.
Sensitivity to inflation regime: The influence of money growth on inflation appears to depend on the prevailing trend level of inflation, implying that the predictive and policy role of monetary aggregates may change across inflation regimes.