Abstract
<p><em>The search for robust model to predict inflation within a QTM framework gave birth to P-star model which has attracted less attention of researchers and practitioners in Nigeria. This study applied the methodology to high frequency Nigerian data from 1995M1 to 2018M6 to determine the validity of the model for Nigeria using error correction model (ECM). The result supports the working of the model but with slight modification. The modification centres on the incorporation of foreign price gap, (open economy view of inflation), reserve money (Friedmanic/monetarist view), price per litre of petroleum motor spirit (PMS) and output gap (Structuralist view). With this modification, P-star model proved to be a viable inflation forecasting alternative model for Nigeria. Consequently, the Central Bank of Nigeria is advised to consider adopting this modified version of the model to forecast inflation for Nigeria at least as a complimentary model to be used side-by-side with the existing forecasting model of the Bank. This will no doubt enhance the efficacy of the monetary policy of the Bank as such policies will be predicated on sufficient information, particularly on the future path of inflation.</em></p>
Highlights
The historical relationship between monetary aggregates and prices seems to have been distorted
The vector Z is first considered in Model 3 by addition of reserve money reflecting Friedmanic proposition otherwise known as monetarist view on inflation
Model 1 as reported in Table 3 shows that domestic price gap on its own is not adequate to explain inflation dynamics in Nigeria
Summary
The historical relationship between monetary aggregates and prices seems to have been distorted. According to the key proponents of this view, the doubt on the continuous relevance of monetary aggregates in determining the general price level, and in some cases, the level of economic activity is gradually rendering money supply increasingly irrelevant and less useful, ceased to maintain its position in monetary policy decision making process in the developed countries, some Emerging Market Economies (EMEs) and developing countries. Most of these countries have adopted alternative strategies of monetary policy formulation. The methodological framework for empirical implementation is outlined in section three, while section four discusses the results and the last section concludes
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