DP126 Granger Causality and Policy Ineffectiveness: A Rejoinder
|Author(s):||Willem H. Buiter|
|Publication Date:||September 1986|
|Keyword(s):||Granger Causality, Policy Effectiveness, Rational Expectations|
|JEL(s):||023, 026, 211|
|Programme Areas:||International Macroeconomics|
|Link to this Page:||cepr.org/active/publications/discussion_papers/dp.php?dpno=126|
In an earlier paper "Granger-causality and Policy Effectiveness" Economica (1984), I showed that for a policy instrument x to Granger-cause some target variable y it 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 Sargent). 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: 1. 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 from that used by the public. 3. The controller may not have a perfectly specified or estimated model of the economy. The analysis confirms that Granger-causality tests are uninformative about the presence, absence, degree or kind of policy (in)effectiveness.