Monetary and Non-Monetary Analyses of Inflation in a Small Open Country

Monetary and Non-Monetary Analyses of Inflation in a Small Open Country This paper (re)evaluates monetary and non-monetary inflation models for the Netherlands. In particular, we examine whether a P-star model - representing a textbook macroeconomic relationship between money and prices - should be rejected in favour of a popular socio-political model based on cost-push factors. We argue that the P-star model can be used for a small economy with fixed exchange rates and conclude that the P-star model need not be rejected on theoretical grounds. We also show that based on in-sample fit and out-of-sample forecasting the monetary model is not outperformed by the socio-political model. Thus, the P-star model need not be rejected on empirical grounds. Basic monetary economics suggests that we should prefer the monetary inflation model. We conclude with some observations on the political-economy aspects of the public debate on inflation and its determinant