7/2005 Aurelijus Dabušinskas. Money and prices in Estonia

Working Papers of Eesti Pank. No 7, 2005

This paper examines the relationship between money and prices in Estonia in the period 1997Q1-2003Q3. The concept of a price (or real money) gap suggested by the P-star theory is applied to investigate whether information about the current money stock can be used to explain and/or predict GDP deflator inflation over the sample period. The results show that the money gap measure dominates the output gap as an explanatory variable for inflation in the short run. However, the money gap does not seem to be a proper indicator for predicting inflation over longer horizons, say, 12 months ahead. There are some signs that the output gap is becoming a better indicator of future inflation over time, but more data are needed to confirm this hypothesis.
JEL Code: E31, E41
Key words: P-star, inflation, money demand

* I would like to thank Rasmus Kattai, David Mayes and Martti Randveer for their useful comments and suggestions. All remaining errors are mine.

Author's e-mail address: aurelijus.dabusinskas [at] epbe.ee

The views expressed are those of the author and do not necessarily represent the official views of the Eesti Pank.

Contents

1. Introduction
2. Methodology
3. Estimating the Demand for Money
4. Calculating the Money Gap
5. Modelling GDP Deflator Inflation: Money Gap versus Output Gap
6. Conclusions
References

Money and Prices in Estonia, Working Papers of Eesti Pank No 7, 2005 (PDF*)

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