Monetary approach to inflation: A medium-term structural model in a small open economy (the case of the Czech Republic in 1996-2004)

The paper analyses a relationship between monetary aggregate M2 and inflation in a small open economy. The relationship between monetary expansion and inflation as well as a dynamic of income velocity of money framework in a small open economy are discussed in more details in the paper. Authors have developed a medium-term structural model using for an empirical verification of the relationship between monetary aggregate M2 and price development in tradable and non-tradable goods and services in the Czech Republic in the period 1996-2004. The empirical results of the model indicate that money has a significant impact on the price development of non-tradables. On the other hand, a statistically significant relationship between money and tradables inflation in the case of the Czech small open economy is not found. The conclusions presented in the paper suggest that the monetary aggregate should not be ignored in practical policy-making.