Does the P* Model Provide Any Rationale
for Monetary Targeting?

 

Lars E.O Svensson
Princeton University,
CEPR and NBER

First draft: May 1998
This version: June 1999

 

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 Classification Numbers: E42, E52, E58

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