Markov Switching Causality and the Money-Output Relationship

30 Pages Posted: 23 Apr 2003

See all articles by Zacharias Psaradakis

Zacharias Psaradakis

University of London - Economics, Mathematics and Statistics

Morten O. Ravn

European University Institute - Economics Department (ECO); London Business School - Department of Economics; University of Southampton; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER)

Martín Sola

Universidad Torcuato Di Tella; University of London - Economics, Mathematics and Statistics

Date Written: February 2003

Abstract

The empirical relationship between money and output is one of the most studied issues in macroeconomics, and a large literature has examined the causal links between monetary variables and output. One puzzle from this literature is that the results of causality tests appear to be sensitive with respect to the sample period that one considers. As a way of overcoming this problem, we propose a new method for analysing causal links that allows for changes in these links over the sample period. Our method is based on a VAR model with time-varying parameters. We model the time-variation in the parameters as reflecting changes in causality, and assume that these changes are stochastic and governed by an unobservable finite Markov chain. One important advantage of our method relative to alternative methods is that it allows for arbitrarily many changes in causal links during the sample and enables the identification of sample points at which causality has changed. When applied to US data, we obtain results that allow us to reconcile previous puzzling differences in the outcome of standard Granger causality tests.

Keywords: Granger causality, Markov chain, regime switching, structural instability

JEL Classification: C32, E52

Suggested Citation

Psaradakis, Zacharias and Ravn, Morten O. and Sola, Martín, Markov Switching Causality and the Money-Output Relationship (February 2003). CEPR Discussion Paper No. 3803. Available at SSRN: https://ssrn.com/abstract=397420

Zacharias Psaradakis

University of London - Economics, Mathematics and Statistics ( email )

7-15 Gresse Street
London, WC1E 7HX
United Kingdom
+44 20 7631 6415 (Phone)
+44 20 7631 6416 (Fax)

HOME PAGE: http://www.econ.bbk.ac.uk/faculty/psaradakis/

Morten O. Ravn (Contact Author)

European University Institute - Economics Department (ECO) ( email )

Villa San Paolo
Via della Piazzuola 43
50133 Florence
Italy

London Business School - Department of Economics ( email )

Sussex Place
Regent's Park
London NW1 4SA
United Kingdom
+44 20 7262 5050 ext. 3717 (Phone)
+44 20 7402 0718 (Fax)

University of Southampton ( email )

University Rd.
Southampton SO17 1BJ, Hampshire SO17 1LP
United Kingdom
+44 1703 593996 (Phone)
+44 1703 593858 (Fax)

Centre for Economic Policy Research (CEPR)

London
United Kingdom

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Martín Sola

Universidad Torcuato Di Tella ( email )

Minones 2159
1428 Buenos Aires, 1428
Argentina
5411 4784 0080 (Phone)
5411 4784 9807 (Fax)

University of London - Economics, Mathematics and Statistics ( email )

Malet Street
London, WC1E 7HX
United Kingdom
+44 20 7631 6411 (Phone)
+44 20 7631 6416 (Fax)

HOME PAGE: http://www.econ.bbk.ac.uk/faculty/sola/

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