The P* Model and Its Performance in the Iranian Economy (1338-82)

This paper studies the usefulness of the P* (P-Star) model in the analysis of the behaviors of prices in Iranian economy. The P* model is based on the Quantity of Theory of Money. This model belief that the price level tends to move towards the equilibrium price level. The P*model uses prices gap to forecast inflation, if the equilibrium price is greater than the current price, there is a tendency for the price level to rise and vice versa. Potential output, the equilibrium velocity of money and the amount of money in the economy determine the equilibrium price in this approach. In this study, potential output and equilibrium velocity are derived using the Hodrick and Prescott filter.The results do not support the P-star model for Iranian Prices. According to the proponents of the P-star model the lagged value of the price gap must be significant in the model of inflation. But results of this study indicate that the lagged value of the price gap is no significant, so P-star model is not useful in forecasting inflation in Iran.