Improving inflation prediction with the quantity theory

•We consider the role of the quantity theory in improving inflation forecasts.•We find that the cointegration-based quantity theory does not hold for the period after 1995 for the US data.•That period is well explained by an adaptive quantity theory based on a functional-coefficient cointegration that adapts to the unemployment rate.•The forecasting exercises show that the adaptive quantity theory has superior pre-dictive power for targeting future inflation.

This paper focuses on the role of the quantity theory in improving inflation forecasts. We find that the cointegration-based quantity theory does not hold for the period after 1995 for the U.S. data. However, that period is well explained by an adaptive quantity theory based on a functional-coefficient cointegration that adapts to the unemployment rate. The forecasting exercises show that the adaptive quantity theory has superior predictive power for targeting future inflation.