Granger Causality, Exogeneity, Cointegration, and Economic Policy Analysis
36 Pages Posted: 30 Nov 2012
Date Written: October 31, 2011
Policy analysis had long been a main interest of Clive Grangers. Here, we present a framework for economic policy analysis that provides a novel integration of several fundamental concepts at the heart of Grangers contributions to time-series analysis. We work with a dynamic structural system analyzed by White and Lu (2010) with well de ned causal meaning; under suitable conditional exogeneity restrictions, Granger causality coincides with this structural notion. The system contains target and control subsystems, with possibly integrated or cointegrated behavior. We ensure the invariance of the target subsystem to policy interventions using an explicitly causal partial equilibrium recursivity condition. Policy effectiveness is ensured by another explicit causality condition. These properties only involve the data generating process; models play a subsidiary role. Our framework thus complements that of of Ericsson, Hendry, and Mizon (1998) (EHM) by providing conditions for policy analysis alternative to weak, strong, and super-exogeneity. This makes possible policy analysis for systems that may fail EHMs conditions. It also facilitates analysis of the cointegrating properties of systems subject to policymaker control. We discuss a variety of practical procedures useful for analyzing such systems and illustrate with an application to a simple model of the U.S. macroeconomy.
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