Date of Award

Spring 1992

Project Type

Dissertation

Program or Major

Economics

Degree Name

Doctor of Philosophy

First Advisor

Evangelos O Simos

Abstract

The positive relationship between the rate of growth of the money supply and the rate of growth of aggregate income is a widely accepted principle in macroeconomics. However, the direction of the causality between these two variables has been an enduring subject of controversy.

Recent developments in time series analysis, particularly those relating to the concepts of integration and cointegration, and the stationary nature of economic time series, promise to help settle the debate on the statistical relationship between money supply growth and income growth. Most of the recent work on this issue, however, has been confined to a closed economy framework and has dealt only with US data. This dissertation extends the scope of the recent work on money-income causality to an open economy framework. Three distinctly different economies are investigated: the United States (large economy), Canada (smaller, fairly open economy), and the Netherlands (small, very open economy). The impact of two international variables (world money supply and world aggregate income) on the direction of causality between domestic money supply and domestic income are explicitly examined, using monthly data over the period 1960-1990 and optimally selected lags for the model specifications. Money-income causality is tested over the full sample (1960-1990), and over sample periods corresponding to alternative exchange rate regimes.

For all three economies, the exchange rate regime is found to be a critical factor in the direction of the causality between domestic money supply and domestic income. In most cases, however, the two international variables (world money supply and world income) do not appear to have a significant impact on the direction of the causality. The empirical results from this study support the predictions of the standard open economy macroeconomic theory (the Mundell-Fleming model) in one half of the cases. This dissertation also confirms earlier findings on the sensitivity of Granger causality tests to lag length selection.

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