Working Paper: CEPR ID: DP2198
Authors: Lars E. O. Svensson
Abstract: The so-called P* model is frequently used or referred to in discussions of monetary targeting. This gives the impression that the P* model might provide some rationale for monetary targeting or for the monetary reference value used by the Eurosystem. The P* model implies that inflation is determined by the level of and changes in the "real money gap" (the deviation of current real balances from their long-run equilibrium level), and hence that the real money gap is an important indicator for future inflation. Nevertheless, the P* model does not seem to provide any rationale for either a Bundesbank-style money-growth target or a Eurosystem-style money-growth indicator.
Keywords: real balances; reference value; inflation targeting
JEL Codes: E42; E52; E58
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| lagged price gap (E30) | inflation (E31) |
| real money gap (J31) | inflation (E31) |
| current inflation + current real money gap (E31) | one-period-ahead inflation forecast (E31) |
| future real money gaps + current inflation (E31) | t-period-ahead inflation forecast (E31) |
| inflation forecast (E31) | price stability risks (E31) |
| real money gap (J31) | Bundesbank-style money growth target (E52) |
| current money growth indicator (O42) | future inflation deviations (E31) |