The question whether real money causes real output appears to
be important for many economists working in the area of macroeconomics
and, has been subjected to a variety of modern econometric techniques,
producing conflicting results. One often applied method to investigate
the empirical relationship between money and real activity is Granger
causality analysis [Granger (1969)]. Using this approach, the causality
question can be sharply posed as whether past values of money help to
predict current values of output. This concept, however, should be
clearly distinguished from any richer philosophical notion of causality
[cf. Holland (1986)]. Present paper examines the relationship between
money (both M1 and M2) and income (Real GDP) for 15 developing countries
using a newly developed heterogeneous dynamic panel data approach.1 Sims
(1972) postulated “the hypothesis that causality is unidirectional from
money to income agrees with the post war U.S. data, whereas the
hypothesis that causality is unidirectional from income to money is
rejected”. Since then a voluminous literature has emerged testing the
direction of causality.2 Some studies have tested the relationship
between these variables and the direction of causality for a particular
country using time series techniques [e.g., Hsiao (1979) for Canada,
Stock and Watson (1989) for U.S. data, Friedman and Kuttner (1992, 1993)
for U.S. data, Thoma (1994) for U.S. data, Christiana and Ljungquist
(1988) for U.S. data, Davis and Tanner (1997) for U.S. data, Jusoh
(1986) for Malaysia, Zubaidi, et al. (1996) for Malaysia, Biswas and
Saunders (1998) for India, and Bengali, et al. (1999) for Pakistan].
Other studies have tested the above on a number of countries, for
example Krol and Ohanian (1990) used the data for Canada, Germany, Japan
and the U.K. Hayo (1999) using data from 14 European Union (EU)
countries plus Canada, Japan, and the United States. More recently Hafer
and Kutan (2002) used a sample of 20 industrialised and developing
countries. This paper contributes to this later strand of the
literature, which it extends in three directions. First, it employed a
newly developed panel cointegration technique [Larsson, et al. (2001)],
to examine the long-run relationship between money and income. Second,
the study performs panel causality test, recently developed by Hurlin
and Venet (2001), to explore the direction of causality between the said
variables. Third, the important contribution of the present study is to
test whether relationship between money and income is homogeneous or
heterogeneous across countries.
The Causal Relationship between Inflation and Unemployment: A Panel Cointegration and Causality Analysis