Granger-Causality and Stabilization Policy

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This paper aims to provide a stochastic, rational expectations extension of Tobin's "Money and Income; Post Hoc Ergo Proper Hoc?". It is well-known that money may Granger-cause real variables even though the joint density function of the real variables is invariant under changes in the deterministic components of the monetary feedback rule. The paper shows that failure of money to Granger-cause real variables does not preclude a stabilization role of money. In a number of examples the conditional second moment of real output is a function of the deterministic components of the monetary feedback rule. Yet money fails to Granger-cause output ("in mean" and "in variance"). In all these models money is a pure stabilization instrument: superneutrality is assumed. If the analysis is extended to "structural" or "al1ocative" instruments such as fiscal instruments, the conclusion is even stronger. Failure of these policy instruments to Granger-cause real variables is consistent with changes in the deterministic parts of the policy feedback rules being associated with changes in the conditional means of the real variables. Granger-causality tests are tests of "incremental predictive content". They convey no information about the invariance of the joint density function of real variables under changes in the deterministic components of policy feedback rules.

Published: Buiter, Willem H. "Granger-Causality and Stabilization Policy." Economica, Vol. 51, pp. 151-162, May 1984.

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