Macroeconomic activity dynamics and Granger causality: new evidence from a small developing economy based on a vector error-correction modelling analysis
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The main purpose of this paper is to discern the dynamic causal chain (in the Granger (temporal) sense rather than in the structural sense) among real output, money, interest rate, inflation and the exchange rate in the context of a small Asian developing economy, such as Indonesia. The methodology employed uses various unit root tests and Johansen's cointegration test followed by vector error-correction modelling, variance decompositions, and impulse response functions in order to capture both the within-sample and out-of-sample Granger causal chain among macroeconomic activity. Given the inward-oriented growth strategy of this small developing economy, where the real output was vulnerable to vicissitudes of the agricultural sector and exports (particularly oil), our results are quite in line with our expectations, and tend to suggest that in the Granger-causality sense, output was relatively the leading variable being the most exogenous of all, and all other variables including money supply, rate of interest, exchange rate, and prices had to bear the brunt of adjustment endogenously in different proportions in order to accommodate that real shock. The Granger-causal chain implied by our evidence that real output more often predominantly leads (rather than lags) money supply and the other three endogenous variables, is consistent more with the recent real business cycle (RBC) theory than with the other two major macroeconomic paradigms such as the Keynesian and the monetarist. This finding has clear policy implications for any accommodative and/or excessive monetary expansion since it is likely to be dissipated in terms of relatively higher nominal variables, such as prices, exchange rates or interest rates rather than real output, for a small developing economy like Indonesia in the context of a relatively unstable macroeconomic environment.
Macroeconomic , Cointegration , Causality
Masih, Rumi and Mohammed Masih, Abul Mansur. (1996). Macroeconomic activity dynamics and Granger causality: new evidence from a small developing economy based on a vector error-correction modelling analysis. Economic Modelling, 13, pp. 407-426.
Elsevier Science B.V.