Abstract:
This paper studies the usefulness of the P*-model in the analysis of the
behaviour of prices in Iranian economy. The P*-model is based on the Quantity of
Theory of Money. This model believes that the price level tends to move towards
the equilibrium price level. The P* model uses price gap to forecast inflation,
if the equilibrium price is greater than the current price, there is a tendency
for the price level to rise and vice versa. The equilibrium price in this
approach is determined by potential output, the equilibrium velocity of money
and the amount of money in the economy. In this study, potential output and
equilibrium velocity are derived using the Hodrick and Prescott filter.
Machine summary:
"Keywords: P-star model, Potential Output, Equilibrium Price, Long-Run Velocity, Forecast of Inflation.
1. Introduction The Quantity Theory of money postulates that a long-run relationship between money and the price level provides a basis for modeling inflation.
Nonetheless, Hallman, Porter and Small(HPS) introduced a model based on the theory of money to forecast inflation, which refer to the equilibrium level of price(P-star) to which actual prices(P) tend to adjust.
Thus, measuring potential output and long-run velocity is a crucial task of any study which uses the P-star framework.
Based on equation 1, HPS define the equilibrium price level (P-star) in the following manner: (2) Where Y* is the potential real output and V* is the equilibrium velocity of money.
3. Calculation of Equilibrium Price Level (P-star) Calculating the equilibrium price level (which is an unobserved variable); one needs the estimates of potential output and long-run velocity of money.
Therefore, in this study the Hodrick-Prescott filter, an appropriate filter for stochastic trends, is used to measure the long-run values of GDP and the velocity of money.
Once the potential output and the long-run velocity of money series are constructed, the equilibrium price (P-star) is defined using equation (2) and the price gap(P-P*)is used to model inflation In Iran.
9 Lagged Number 1 2 2 2 As noted above the equilibrium paths for output and velocity of money, which are needed for obtaining the equilibrium price level (P-star), were constructed using the HPF, the price gap must have an inverse relation with the actual inflation rate."