The role of monetary aggregates in the CNB's forecasts

Monetary aggregates do not enter the CNB forecast directly. The reason for this is that under inflation targeting, where the central bank controls interest rates and withdraws excess liquidity from the money market, the money supply merely reflects economic growth, monetary policy measures and the expectations of economic agents. Nonetheless, monetary aggregates can be used as an auxiliary indicator for verifying the forecast if they contain information on the present or future development of the economy. The CNB therefore analyses, along with numerous other economic indicators, the development of monetary aggregates. This Box summarises the analysis of the information content of the monetary aggregates using the "monetary overhang" and the nominal and real "money gap". These concepts are routinely used by the ECB to analyse monetary aggregates.

The monetary overhang is defined as the percentage deviation of the actual money supply level from the level corresponding to the current position of the economy in the cycle and other fundamentals. It is calculated based on the standard estimate of money demand. The nominal money gap is defined as the percentage deviation of the actual M2 stock from the level it would reach if it grew at the rate reflecting the potential of the economy and the inflation target. The real money gap is defined as the nominal money gap "adjusted" for the difference between CPI inflation and the inflation target. The money gap concept differs from the monetary overhang in that in the case of the latter we analyse the extent to which M2 growth is in line with the actual development of the economy, whereas in the case of the former we investigate the extent to which M2 growth is in line with the long-term equilibrium trends in the economy.

Chart 1: The monetary overhang


Chart 2: The nominal money gap


Chart 3: The real money gap

Charts 1, 2 and 3 of this Box present the resulting estimates of the monetary overhang and the money gap. These indicators are not currently positive, hence they are not signalling any inflation risks in the medium term. The resulting monetary indicators can also be statistically tested as an indicator of future CPI inflation. The analyses conducted reveal that these indicators do not have a significant information content in the Czech Republic as regards forecasting inflation at the monetary policy horizon.