P* Type Models: Evaluation and Forecasts

Abstract

Recently members of the research staff of the Board of Governors have constructed a model of the inflation process that has received considerable attention.' The purpose of this paper is to review critically the assumptions that are the basis of that inflation model and to examine a model of nominal income, real output and inflation that is implicit in the assumptions of that model, given the behavior of the monetary base and potential real output. In section I, the fundamental assumptions of the P' model are examined in light of the existing literature on the behavior of M2 velocity. In section II some implicit assumptions of the P' model about the behavior of velocity of the monetary base and the base-M2 multiplier are discussed and developed. An explicit statistical model of these variables is estimated, which satisfies the assumptions of the P' model is estimated. In section III, the historical performance and forecasts of that model are examined.

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