Money as an indicator for inflation and output in Chile - not anymore?

This paper identifies the information content of monetary aggregates for output and inflation in Chile, using a large set of reduced-form statistics and regression specifications. Unlike almost all previous studies on money in Chile, we compare 10 traditional and new definitions of money, rather than just looking at the customary definition M1A. Also, given the changes in the financial system and disinflation in Chile over the last 20 years, as well as contrasting growth rates of GDP and narrow money in recent times, we report recursive estimations for all our statistics to highlight parameter constancy. While there seems to be a strong and often one-to-one association between money growth and inflation on average over the whole sample as indicated by Nelson (2003) type regressions, the relation drops strongly during the last 10 years, and thus seems much lower in times of low inflation. Also, an increase in nominal money growth never causes acceleration of inflation in a Granger sense. However, we do find a significant and positive impact of deviations from (an estimated or HP-filtered) equilibrium level of money holdings on inflation, as indicated by error-correction and Pstar models. But the deviations from a simple estimated equilibrium are very large for both broad money aggregates and M1A at the end of the sample, casting some doubt on the stability of their demand relation. Accordingly, cointegration tests for the existence of a stable demand for money function over the whole sample are somewhat inconclusive. We find a strong Granger causality relationship between money and output, which however vanishes once we control for the effect of past inflation and changes in the monetary policy rate. Also, the information in lags of M1A for GDP drops strongly towards the end of the sample. More generally, M1A does not seem to merit its role as the money sum par excellence in Chile, being inferior in information content for example to Notes and Coin, or a broad money sum excluding bonds (M7 minus Central Bank documents).