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On the Temporal Causal Relationship between Macroeconomic Variables: Empirical Evidence from India

P., Srinivasan and M., Kalaivani (2013): On the Temporal Causal Relationship between Macroeconomic Variables: Empirical Evidence from India.

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Abstract

The present study examines the dynamic interactions among macroeconomic variables such as real output, prices, money supply, interest rate and exchange rate in India during the pre-economic crisis and economic crisis periods, using the ARDL bounds test for cointegration, Johansen and Juselius (1990) multivariate cointegration test, Granger causality/Block exogeneity Wald test based on Vector Error Correction Model, variance decomposition analysis and impulse response functions. The empirical results reveal a stronger long-run bilateral relationship between real output, price level, interest rate and exchange rate during the pre-crisis sample period. Moreover, the empirical results confirm a unidirectional short-run causality running from price level to exchange rate, interest rate to price level and real output to money supply during the pre-crisis period. Also, it is evident from the test results that there exist short-run bidirectional relationships running between real output and exchange rate, price level and interest rate in the pre-crisis era. In addition, the feedback relationship is also observed between interest rate and exchange rate variables in the short-run. Most importantly, long-run bidirectional causality is found between real output, exchange rate and interest rate during the economic crisis period. And the study results indicate short-run bidirectional causality between money supply and exchange rate, interest rate and price level and interest rate and output in India during the crisis era. Also, a short-run unidirectional causality runs from prices to real output in the crisis period.

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