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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.
JEL Classification: E19.