Forecasting inflation with excess liquidity and excess depreciation: The case of Angola

This paper presents a country case study investigating whether home goods prices in Angola are better forecasted with innovations in the money market or with innovations in the real exchange rate. Using monthly data from 2007m03 to 2019m03, we propose a reduced form error correction representation to model the long-run and short-run relationships between money, the exchange rate, terms of trade, and the price level. In the long run, a stable money demand function and a relationship between the real exchange rate and terms of trade are identified. In the short run, results indicate that “excess depreciation” (defined as deviations of the exchange rate from its long-run relationship) outperforms the “excess liquidity” (defined as deviations of money from the level implied by the determinants of money demand) in forecasting changes in home goods prices.