Granger-Causality and Policy Ineffectiveness: A Rejoinder
NBER Technical Working Paper No. 61
In an earlier paper,"Granger-causality and Policy Effectiveness," Economica , I showed that for a policy instrument x to Granger-cause some target variable y is not necessary for x to be useful in controlling y. (The argument that it is not sufficient was already familiar, e.g. from the work of Sargenti. Using a linear rational expectations model I showed that x would fail to Granger-cause y (while Y did, in some cases, Granger-cause x) if x were set by a variety of optimal, time-consistent or ad hoc policy feedback rules. Yet in all the examples, x was an effective policy instrument. In response to some comments by Professor Granger, I now show that my earlier results are unaffected when the following 3 concessions to "realism" are made: I. Controllers do not have perfect control of the instruments (this was already allowed for in my earlier paper). 2. Governments may use a different information set to determine instruments than that used by the public. 3. The controller may not have perfect specifications and estimates of models of the economy. The analysis confirms that Granger-causality tests are uninformative about the presence, absence, degree or kind of policy (in)effectiveness.