Long Run Evidence on Money Growth and Inflation

Abstract

Over the last two centuries, the coherence between either narrow or broad money growth and inflation at zero has exhibited little variation-being, most of the time, close to one-in the US, the UK, and several other countries, thus implying that the fraction of inflation's long-run variation explained by long-run money growth has been very high and relatively stable. The gain at zero, on the other hand, has exhibited significant changes, being for long periods of time smaller than one. The unitary gain associated with the quantity theory of money appeared in correspondence with the inflationary outbursts associated with World War I and the Great Inflation - but not World War II - whereas following the disinflation of the early 1980s the gain dropped below one for all the countries and all the monetary aggregates I consider, with one single exception. I propose an interpretation for this pattern of variation based on the combination of systematic velocity shocks and infrequent inflationary outbursts.

Keywords: Quantity theory of money, inflation, frequency domain, cross-spectral analysis, band-pass filtering, DSGE models, Bayesian estimation, trend inflation

JEL Classification: E30, E32