A 3-gap apporach to forecast inflation: the case of Norway

Abstract

This paper presents a case study of whether prices in Norway can be forecasted by innovations in the real exchange rate, real money demand or the GDP gap. Using quarterly data from 2004Q1 to 2021Q4, I identify two long-run relationships in both the real money demand and the real exchange rate respectively. In the short run, I find that liquidity gap (defined as deviations in the real money demand from its long-run relationship) and RER gap (defined as deviations in the real exchange rate from its long-run relationship) are significant in forecasting GDP price deflator, while GDP gap is insignificant