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Monetary neutrality in developing economies: The case of the Dominican RepublicJosé R. Sánchez-Fung*Pontifica Universidad Católica Madre y Maestra (PUCMM) and Instituto Technológico de Santo Domingo (INTEC), Santo Domingo, Dominican Republic*International address for correspondence: EPS#X-10083,
4770 Broadway, AbstractThis paper investigates the classical long run monetary (super) neutrality propositions for the case of the Dominican Republic. After analyzing the integration and cointegration properties of the data, and implementing the Fisher and Seater (1993) tests of neutrality and super-neutrality, it is concluded that money is long run neutral with respect to prices, and that it is long run super-neutral with respect to real GDP. JEL classification: E40 Keywords: Monetary neutrality and super-neutrality; Dominican Republic 1. IntroductionThe long run neutrality proposition states that changes in the level of the quantity of money can influence the level of nominal but not real variables. Long run super- neutrality is the proposition that affirms that permanent exogenous changes to the rate of growth of the money supply will cause equal changes in nominal variables and will have no impact on the level of real variables. These propositions have been the subject of empirical scrutiny over the years (e.g. Lucas, 1980; Geweke, 1986; Duck, 1993; Bullard and Keating, 1995; Moosa, 1997; Serletis and Koustas, 1998). However, only recently have such analyses been related to the important concepts of non-stationary time series. King and Watson (1992, 1997) and Fisher and Seater (I 993) have advanced the dominant approaches in this line of research. King and Watson provide a way of testing long run neutrality by means of assuming distinct structural assumptions about the economy, while paying special attention to the integration and cointegration properties of the data. Their methodology does not assume money exogeneity, and proposes that, for example, the impact of money on output, or output on money, be tested under alternative identifying restrictions. The results obtained from this methodology, nevertheless, and as pointed out by the authors, critically depend on the restrictions that are implemented in order to identify the equations of the system. Alternatively, Fisher and Seater (1993) (FS hereafter) propose reduced form tests of long run neutrality and super-neutrality. They demonstrate that the restrictions implied by these propositions are conditional on the order of integration of the variables comprised in the analysis. Specifically, neutrality tests are possible only if nominal as well as real variables are at least integrated of order one. Moreover, super-neutrality tests are possible only if the order of integration of the nominal is equal to one plus the order of integration of the real variable. The determination of the order of integration is crucial since to be able to draw conclusions about (super) neutrality the series need to possess permanent stochastic changes in their (growth rates) levels. The main objective of this paper is to assess these long run monetary (super) neutrality propositions for the case of the Dominican Republic (DR)^{[1]}. An analysis of these propositions has not previously been applied to the DR. Furthermore, as pointed out by Moosa (1997), few studies have applied long run (super) neutrality tests to developing economies. This fact is at odds with the belief that these economies should provide an appropriate environment for the testing of such hypotheses, by and large because of their, to some extent, common structural characteristics. For instance, the DR's economy has attributes such as a relatively underdeveloped banking system, and a near insignificant financial market. The intuition here is that the less complicated an economy, the more likely should it be that monetary neutrality holds. The rest of the paper is organized as follows. Section two briefly elucidates FS's methodology. Section three describes the data, analyses its integration and cointegration properties, and applies FS's methodology. Section four concludes. 2. Fisher and Seater's frameworkFisher and Seater's methodology is based on a bivariate, autoregressive representation of money with either a real or nominal variable (e.g. GDP or the price level), that can be written as (1) In equation (1) L is the tag operator, A represents differences, k and I stand for the orders of integration of m and z, respectively, and Q_{0} = h_{0} = 1. Long run neutrality can be tested from equation (1) by analyzing the magnitude of the impact of a money supply shock on output or prices, which is captured by the long run derivative (LRD) (2) If lim_{j6 4 }dm_{t+j}/dm^{1}_{t} = 0 there are no permanent changes in the monetary variable and therefore (super) neutrality cannot be tested. As remarked before, only when k and I are at least integrated of order one are both the nominal money stock and real output subject to permanent shocks. Under these conditions long run neutrality implies LRD_{z,m }= j(1)/ h (1) = 0. When l and k are equal to 1, long run neutrality can be tested by applying OLS to the regression (3) Where, b_{j} is the slope of a scatterplot of z growth rates against m growth rates. When l = 1 and k = 2 super-neutrality is tested in the same fashion by (4) 3. Empirical estimationsIn the empirical analysis to be undertaken below M is nominal Ml, Y is real gross domestic product (GDP), and P is the GDP deflator (1990=100). Nominal money is in millions of DR pesos (DR$) and Y is expressed in real DR$ millions at 1990 prices. The data are annual, ranging from 1950 to 1997, and where obtained from the International Monetary Fund International Financial Statistics. To assess the order of integration of the variables under analysis the Augmented Dickey-Fuller (ADF) test (Dickey and Fuller 1981) is implemented. The results of the ADF unit root tests, shown in Table 1, cannot reject the null hypothesis of a unit root in the levels, nor in the first differences, of both m and p^{[2]}. These seem to be series integrated of order two [I (2)]. In contrast, real GDP, y, is I (1). Figure 1 provides visual support to these findings. According to FS, these orders of integration imply that long run neutrality is testable for the prices-money relation. Meanwhile, long run super-neutrality is the appropriate hypothesis to test for the real income-money relation. Now that the order of integration of the variables has been determined, the Engle and Granger (1987) and the Johansen (1988) techniques can be applied to investigate cointegration among the variables^{[3]}. Table 2 summarizes the outcome of the cointegration analyses. The Johansen cointegration trace test statistic strongly rejects the null hypothesis of no cointegration (r = 0), as well as the null of at most one cointegrating vector (r # 1) at the 95% level of significance for the prices-money relation. Accordingly, the Engle-Granger analysis indicates that the residuals from the OLS static regression for such a relation do not contain a unit root, which implies cointegration between the variables under analysis. Thus, given the above results, prices and money appear to have a long run relationship. So money has an impact on prices in the long run, as predicted by basic classical economics. For the real income-money relation results are somewhat different. No evidence of cointegration between such variables is provided by the Engle-Granger or Johansen cointegration tests shown in Table 2. So we can proceed to apply the FS technique to assess more deeply the super-hypothesis for the income-money relationship in Dominican Republic's economy. The FS test of super-neutrality, in the present context, implies the application of OLS to the equation (5) Estimations of b_{j} in equation (3) are obtained for several values of j. The LRDs are LRD [4] = 0.071 (0.58); LRD [9] = 0.010 (O.06); LRD [141 = 0.044 (0.25); LRD [19] 0.237 (1.66). The values inside the brackets are the j's, while t-statistics are shown in parentheses. The results indicate that the change in the rate of growth of money has no impact, is super-neutral in the long run, on the rate of growth of real income. Therefore, LRD Dy, D 2m = 0 cannot be rejected^{[4]}. 4. ConclusionThe purpose of this paper has been to assess the classical long run monetary (super) neutrality hypotheses for the Dominican Republic, using annual data for the period 1950-97. After analyzing the integration and cointegration properties of the data. and implementing the Fisher and Seater (1993) test of neutrality, a long run relationship between prices and money could not be rejected. This outcome provides empirical support to the classical hypothesis of the neutrality of money on prices. In contrast, no cointegration was found between real GDP and money, while the FS test could not reject the super-neutrality of the latter on the former for the case being studied. These results are of great importance for the conduct of monetary polky. For example, the Central Bank could try to control inflation knowing that there is a stable long run relation between money and prices and should not systematically attempt to influence real economic activity through monetary policy manipulation of the money supply. ReferencesBullard, James and John W. Keating (1995) The long-run relationship between inflation and output in postwar economies, Journal of Monetary Economics, 36,477-496. Dickey, D.A. and W.A. Fuller (1981) A likelihood ratio test for autoregressive time series with a unit root, Econometrica, 49, IOS7-1072. Duck, Nigel (1993) Some international evidence on the quantity theory of money, Journal of Money, Credit, and Banking, 25, 1-12. Engle, Robert F. and Clive W.J. Granger (1987) Cointegration and error correction: representation, estimation, and testing, Econometrica, 55, 251-276. Fisher, Mark E. and John J. Seater (1993) Lolig-run neutrality and supemeutrality in an ARIMA framework, American Economic Review, 83, 402-415. Geweke, John F. (1987) The superneutrality of money in the United States: an interpretation of the evidence, Econometrica, 54, 1-21. Johansen, Soren (1988) Statistical analysis of cointegrating vectors, Journal of Economic Dynamics and Control, 12, 231-254. King, Robert G. and Mark W. Watson (1992) Testing long-run neutrality, working paper no. 4156, National Bureau of Economic Research, Boston, September. King, Robert G. and Mark W. Watson (1997) Testing long-run neutrality, Federal Reserve Bank of Richmond Economic Quarterly, 83, 69-101, Summer. Lucas, Robert E. Jr. (1980) Two illustrations Df the quantity theory of money, American Economic Review, 70, 1005-1014. Lucas, Robert E. Jr. (1996) Nobel lecture: monetary neutrality, Journal of Political Economy, 104, 661-682. MacKinnon, J.G. (1991) Critical values for cointegration tests, Chapter 13 in R.F. Engle and C.W.J. Granger (Eds.), Long-run economics relationships: readings in cointegration, Oxford University Press. Moosa, Imad A. (1997) Testing the long-run neutrality of money in a developing economy: the case of India, Journal of Development Economics, 53, 139-155. Osterwaid-Lenurn, Michael (1992) A note with quantiles of the asymptotic distribution of the maximum likelihood cointegration rank test statistics, Oxford Bulletin of Economics and Statistics, 54, 461-471. Patinkin, Don (1987) Neutrality of money, in John Eatwell, Murray Milgate, and Peter Newman (Eds.), The newpalgrave: a dictionary of economics, Vol. 3, New York: Stockton, 639-645. Serletis, Apostolos and Zisimos Koustas (1998) International evidence on the neutrality of money, Journal of Money, Credit, and Banking, 30, 1-25. Tables and FiguresTable 1: Unit root tests 1954-97 Table 2: Cointegration analysis 1950-97 Figure 1: Unit root tests 1954-97 Footnotes^{[1]}Pafinkin (1988) provides a broad theoretical overview of the concept of monetary neutrality. See also Lucas (1996). ^{[2]}Small caps denote logs of the variables. ^{[3]}FS argue that cointegration by itself does not influences the restrictions they derive. However, they also note for bivariate cases cointegration is enough to reject long run (super) neutrality. For more details see the appendix in FS (1993), page 414. ^{[4]}Although, as noted by both King and Watson (1992) and Fisher and Seater (1993), cointegiration is enough to reject long run (super) neutrality, the FS test was also applied to the prices-money relation, which was found to cointegrate. The results, available from the author upon request, support the hypothesis of a non-neutral impact of money on prices in the long run. |