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Oxford Economic Papers Advance Access published online on April 14, 2008
Oxford Economic Papers, doi:10.1093/oep/gpn013
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© Oxford University Press 2008 All rights reserved

Does high M4 money growth trigger large increases in UK inflation? Evidence from a regime-switching model

Costas Milas

Department of Economics, Keele University, ST5 5BG; and Rimini Centre for Economic Analysis, Rimini, Italy; e-mail: c.milas{at}keele.ac.uk


  Abstract

March 2007 saw an increase of 3.1% in UK inflation and triggered the first explanatory letter from the Governor of the Bank of England to the Chancellor of the Exchequer since the Bank of England was granted operational independence in May 1997. The letter gave rise to a lively debate on whether policymakers should pay attention to the link between inflation and M4 money growth. Using UK data since the introduction of inflation targeting in October 1992, we show that: (i) the relationship between inflation and M4 growth is not stable over time, and (ii) the tendency of M4 to exert inflationary pressures is conditional on annual M4 growth exceeding 9.8%. Above this threshold, the money effect on inflation is very small. The implication is that the Monetary Policy Committee should not be particularly worried for not paying close attention to M4 money movements when setting interest rates.

JEL classifications: C51, C52, E52, E58.


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