Expectations, money, and the forecasting of inflation

expected to be reinforced in the future, this
long-run impact can be greater than unity.
Hence the more persistent that money changes
are expected to be, generally the larger will be
the apparent long-run impact of money on
prices measured from money-inflation forecast-
ing relations.

More generally, future money may be pre-
dicted from information other than its past;
letting z(t) stand for such additional informa-
tion (which will usually include past data), we
might then have,

m*(t) = B(L)m(t) + z(t).            (12)

Plainly, the relation used to forecast prices
then must include z(t). Conversely, the fact
that non-monetary variables are useful in “ex-
plaining” or predicting inflation in standard re-
lations does not necessarily mean that they can
directly affect prices, independently of money.

To summarize the implications of this view.
when prices respond to permanent money as
defined here:

i) The long-run impact of money on prices
measured from inflation-forecasting equations
will depend upon how future money is fore-
casted, and generally will not be unity.

ii) When current money changes are typi-
cally viewed as transient, the long-run impact
of money on prices will generally be less than
unity, and less than when such changes are
expected to be permanent or reinforced.

iii) Inflation-forecasting equations should in-
clude all variables used to forecast future
money, and not simply current and past money.
As these indicate, it generally will not be pos-
sible to test propositions about the causal links
between money and prices using only the em-
pirical relation between prices and current and
past money; the same point was made in a
slightly different context by Lucas ¢1970).

Table A.1

Impact of a One-percent Increase in Current Money Growth
on the Expected Future Level of the Money Stock*

’Results are based upon a simulation of the estimates summarized in Table II in the text.

^lThe results for Canada for the first period are unstable in that the absolute value of money changes (although not their
cumulative sum) increases over time. When the model is reestimated suppressing the second autoregressive term, the long-
run impact for the first period is negative and virtually complete after six quarters.

²The Japan results for the first period show considerable "cycling” in the first four quarters: after two quarters the expected
money stock level is up 1.8%, while it is up only .55% after five quarters.

¹The U.S. results for the first period again show substantial “cycling.”

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