The P* model and Austrian prices

In theP ^* model the price level is determined by the money stock per unit of potential out-put and the long-run equilibrium level of the velocity of money. This article applies this model to Austria. Problems in identifying permanent shocks to potential output and/or velocity lead to the rejection of such models of the price level, but their first-difference version is not so suspect. While evidence is found of a long-run relationship between Austria inflation and money growth, even the first-difference version of theP ^* model is rejected for Austria. Since Austria is a small economy, closely tied to Germany, the article also investigates whether Austrian prices are tied to a GermanP ^* measure. This hypothesis is also rejected, but there is a statistically-significant long-run relationship between Austrian and German inflation. Moreover, Austrian money growth remains significant even in this relationship.This article was written while the author was a Visiting Scholar at the Austrian National Bank. The author is indebted to Fritz Breuss, W. Jahnke, and Dieter Proske for help in obtaining the data used here, and for useful discussions about the data, relevant theoretical issues and results. The comments of the referees on an earlier version are also gratefully acknowledged. The views expressed here are those of the author and are not necessarily those of the Austrian National Bank, the Federal Reserve Bank of St. Louis, or the Board of Governors of the Federal Reserve System.