Which of the real money gap or nominal money gap helped predict inflation in Europe? A retrospective analysis.

Summary The question examined in this paper is the following. Assuming that money played a role in the prediction of inflation, which of the nominal money gap or real money gap did the best job in the European countries? Answering this ques- tion helps us to compare the different strategies undertaken by the central banks in the countries that were members of the EMU. In the countries that participated in the Exchange rate mechanism (ERM) and then adopted the Euro, the policy preferences have been dominated by tacking monetary aggregates, while some non-euro countries preferred to focus on the direct effects of real money growth. The authors use panel data econometrics allowing for heterogeneous short-run and long-run dynamics among the countries. An important result is that the real money gap may be equally informative about future inflation. This plays against the dominant view of a quantitative theory approach of inflation in Europe.