The P* model and its performance for the Spanish economy

Vicente Pallardo and Vicente Esteve

Applied Financial Economics, 2000, vol. 10, issue 4, 449-459

Abstract: The performance of the P* model is tested as an inflation forecaster for the Spanish economy. It is shown that log-run relationships work as expected according to the model and the Quantitative Theory of Money. The Error Correction Model constructed by using the gap between actual prices and the long-term equilibrium price level as an error correction term, offers a consistent explanation for the short-run dynamics in prices. On the other hand, the P* approach shows a forecasting ability similar to that presented for other countries in several studies, although the degree of accuracy in the prediction is not specially satisfactory, mainly for the period 1989:3- 1992:3, when the credibility effect generated by the inclusion of the Spanish peseta in the European Monetary System led to an inflation rate much lower than that predicted by the model. Results support the option of a direct inflation target (instead of a monetary aggregate) as the intermediate variable of the monetary policy.

Date: 2000
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DOI: 10.1080/09603100050031570

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