The relationship between money and prices in the maghreb countries: a cointegration analysis
This article explains the money side of prices, and why government currencies have a full understanding of the relationship between money and goods. .. Quantitative easing to support asset prices and to fund government. macroeconomic variables viz., money, interest rate, output and prices in Pakistan. For this Further, the use of VAR based cointegration test helps us by passing. The Relationship Between Money and Prices: Some Historical .. Calomiris ( ) discusses the lack of support for the quantity theory in these historical.
Its relative inflexibility and its soundness are the primary reasons governments do not like monetary gold, and force their preferred alternatives on their citizenry. The vested interest of governments is therefore to discourage, or even ban the use of gold as competing money. The educated people, who are the readers searching for an understanding of prices by reading Keynesian and monetarist-inspired journals and papers, are the ones who have lost their monetary compass entirely.
This is all of us in the welfare states, educated but ignorant about the theory of money, literate but woefully uninformed about the true relationship between money and goods, believing money is a matter for the state. It is us who do not understand the dangers of fiat money issued by the banking system in increasing quantities. Understanding the objective exchange value of money The purchasing power of money in a general sense is regarded as its objective exchange value.
Money is the anchor in a transaction, and contrasts with the subjective value placed on goods. As users of money, it is convenient for us to assume there are no price changes from the money side, so that all subjectivity in pricing is reflected in the goods being exchanged for it. When we render financial accounts, this assumption carries through, as it does in law as well.
However, we are generally aware that over time, if not during our daily lives, the value of money is far from being an objective constant. This raises the question as to on what grounds we base our value of money.
Logically, we can only know the value of money by referring to our most recent experience of its value, and then incrementally back in time, that we might judge its soundness.
This is the reason a resident in Switzerland is likely to have a different appreciation of his francs, compared with a resident in Argentina of his pesos. Paper and digital money have no alternative use-value. To gain credibility, the longer-lived government currencies of today based their integrity on gold or silver, being at one time freely exchangeable into one or other of these monetary metals.
This is no longer the case, which from a theoretical standpoint, places government currencies at a continual risk of losing their credibility as money altogether. This is not an acceptable refutation of the regression theorem described in the paragraphs above, and it is the duty of an economist seeking the truth not to duck this important issue.
Without understanding the relationship between money and goods, errors of monetary policy are inevitable. And as those errors become manifest, the personal freedoms we enjoy between us, by exchanging goods at prices mutually agreed, become restricted through increasingly distortive and counterproductive government interventions.
If total money and credit in an economy are constant over time, and assuming for a moment that the price-benefits of competition, improved manufacturing techniques and technology are put to one side, the general price level can only remain stable if the general preference for holding money relative to goods also remains constant. Money quantities have soared Since the last financial crisis, there has been a massive expansion in the quantities of most currencies.
The following chart shows the expansion of fiat dollars sincewhich has been far greater than the rate of increase prior to the financial crisis, shown by the dotted line. The fiat money quantity records the total amount of money both in circulation and in the banking system in the form of cash and ready deposits.
Without resorting to the evidence of questionable government statistics, it is easy to see that this tripling in money quantity in only nine years has not yet led to the expected increase in the general price level.
Part of the explanation is that monetary inflation has so far predominantly exaggerated asset prices. But any resident living in financial centres will attest that prices are indeed rising more rapidly than government statisticians admit.
Far from being a mystery as to why prices have not yet reflected the rapid expansion of the quantity of money, price rises are indeed on their way, with much of the increases yet to come. Since the financial crisis, monetary expansion has become the dominant factor in raising the general level of monetary preference. Bank deposits have become swollen as bank credit has been expanded, because it takes time for individuals to readjust their cash balances to their economic needs.
Remember, the purpose of money is to act as a bridge between our production and consumption, not as an asset to accumulate. The readjustment of money preferences back to normality is subject to a combination of factors, including the inflation of asset prices, before it affects prices of goods.
The suppression of interest rates continues to generate new deposits by encouraging the expansion of bank credit as well, as the chart above shows. Furthermore, the ownership of all that cash tends to start in a few hands, dispersing into wider ownership over time. However, the move towards a preference for goods, as people try to reduce their burgeoning cash balances, is never matched by an increase in their availability, leading to imports, trade deficits, currency weakness, and rising prices by that route.
This is the reason trade deficits are a consequence of the expansion of bank credit in the hands of consumers. Indeed, without a ready supply of goods from abroad, domestic prices would rise more rapidly as the balance of monetary preferences readjusts towards normality. There are, therefore, two routes through which prices can adjust to the change in monetary preferences for any given currency: When goods are imported, the price rises are often delayed by this roundabout route, and the fact that domestic supply bottlenecks are thereby temporarily alleviated.
Otherwise the consequences are the same. Prices rise to accommodate the swing from money preference towards a preference for goods, instead of production being sustainably stimulated. We must now address the problem on a global basis, because the supply of goods to an individual nation-state expanding the quantity of money relies to a large extent on imports. This cannot be the case when central banks are following the same expansionary policies on a coordinated basis, ignoring, for the purpose of our argument, differentials in savings rates.
The shortage of goods as money-preferences recede cannot be satisfied from another planet, so in aggregate, prices everywhere must rise rapidly to absorb the adjustment in relative preferences.
We do not need to imagine it, because these are precisely the conditions we now face, thanks to the coordination of monetary policies on a global basis. The rate at which the general price level rises is broadly set by the rate at which the preference for money deteriorates in favour of a preference for goods.
The result is the total money stock relative to the total value of all goods reverts to where it was before the quantity of money expanded, but each monetary unit buys considerably less. This in common parlance is hyperinflation, and a crack-up boom as people scramble for goods in a rush to dispose of money altogether.
It may be easier to visualise this effect if the validity of objective exchange values for currencies is dispensed with entirely. The evidence then becomes clear. Today, it is missed by nearly all commentary in the financial press, which focuses on the rapid expansion of debt, ignoring the simultaneous increase in the quantity of money. Inflation and deflation The expressions inflation and deflation are too crude for a proper understanding of money and prices, particularly in the context in which they are commonly used.
Inflation of prices is associated with improving economic conditions, and deflation with falling prices, taken to be evidence of deteriorating economic conditions.
Both assumptions are incorrect, which should become evident from an understanding of the price effects of changes in preferences for holding money relative to goods.
Changes in relative preferences are independent from economic performance, which continues regardless, except to the extent it is disrupted by the expansion and contraction of unsound money as described above. The assumptions of central banks are otherwise, as we have seen. Monetary developments in the US are broadly reflected by similar increases in monetary preferences in other currencies, swollen by credit expansion.
Central bankers believe, without foundation, that rising prices stimulate business, when all they stimulate are the statistics. They fail to understand the consequences of their actions.
The Intertemporal Relation Between Money and Prices: Evidence from Argentina
For the same reasons the establishment has an irrational fear of falling prices, the conditions that are typical of sound money. The deflationists see a fragile banking system, unable to absorb losses from an economic downturn about which they are continually concerned. They argue that a financial crisis will wipe out bank collateral as asset prices fall, leading to a scramble for cash to cover debt obligations. They say this will lead to a fall in prices, repeating the experience of the s depression.
Central bankers now appear to be more concerned about this outcome. In section 4, we present our results and section 5 gives some conclusions. See Figure 1 ; we used monthly data. The period included for the analysis runs from January through March Data before that period seems not to be precise.
Given the long history of inflation in Argentina, the number of significant digits declines as we one further back in time and by the IFS is reporting only one significant digit. As we mentioned before, we study this relationship for two periods separately: January to April and April to December the period under a Currency Board, called the Convertibility.
We exclude the hyperinflation 3 that took place between and and also the period since Convertibility was abandoned, as insufficient observations for this new regime are available. The full period includes a large number of very different monetary, fiscal, exchange rate and political regimes.
Understanding money and prices
In particular, the dynamics of the series change significantly after the introduction of the Currency Board. If the changes in the stochastic processes of the series are sufficiently large, one would expect the relationship between the series to change as well. One important characteristic of a dynamic process is its order of integration. Unit root tests on each of the series over the whole sample period are inconclusive as to the order of integration. We examine each series divided into two periods separately.
The first period is characterized by changing exchange rate regimes and relatively high inflation and growth in the money stock. Rates of changes in money and prices were much lower and the variance of each series was reduced markedly. When we did unit root tests on the sub-samples, the results were significant. The earlier period is integrated and the second is not. Including the hyperinflation period with either of the sub-samples results in non-significant results for the unit root tests.
Consequently, we limit the other analysis to the sub-sample periods. Methodology We begin by studying the statistical properties of the series, to check for stationarity, as this determines the correct model specification. In the case where both variables are integrated of order one, we check for cointegration. Later, we perform graphical intertemporal analysis, Granger causality tests and VARs estimations to determine the relationship between money and prices for Argentina.
This was done for the two sub-sample periods and separately. These two tests do not control endogenously for the possibility of structural breaks in the series. Thus, they may confuse structural breaks with non-stationarity in the series. As these two tests tend not to reject the null of a unit-root, we decided to carry out a set of Dickey-Fuller tests that control endogenously for structural breaks. These are known as recursive, rolling and sequential Dickey-Fuller tests.
Following Banerjee et al. This is known as the recursive DF test. The rolling DF test is based on subsample of fixed size Ts, rolling through the sample. The maximum and minimum DF t-statistics are the criteria for this test.
To perform the sequential test, which allows for a possible single shift or break at every point in the sample for the mean or the slope of the trend, the following equation is estimated using the whole sample: As will be shown in detail in the results section, these tests suggest that the two periods are very different for both series, and consequently, we study them separately.
Correlation and Graphical Analysis Now that we have decided to analyze the two sub-samples separately, we want to determine the nature of the intertemporal relationship between money and prices. One direct and simple way to do this is via a sequential graphical exercise and a correlation analysis.
For the graphical exercise, Lucas' basic idea is used. Lucas studied changes in prices and M1 in the United States. For a filter with properties similar to that of Lucas but which we believe is easier to interpret, we calculate different length moving averages to study the intertemporal nature of the interaction between changes in money and prices. Scattered diagrams are presented.
Value of Money and the Price Level (With Diagram)
Using the log differences of prices and money, 2, 4, 6 and 12 months centered 8 moving averages were computed. We study the dynamics of the relationship by calculating the correlations of contemporary, 1, 2, 4 and 6 lags and 1, 2, 4 and 6 leads in log differences of prices against the log differences in money. Granger Causality Test and VARS The results of the lagged correlations suggest that, at least for the early period, there is a direction of causality from prices to money. This direction is different from that observed in many other countries, from that of the later period, and different from that normally expected from theory.
Given that this result is unusual, we use other standard tests to examine the direction of causality. We do Granger causality tests and structural VARS to see if they support the results from the lagged correlations. Granger causality test are performed to see if changes in one variable help to predict future changes in the another.
Granger causality tests test for temporal precedence. In addition, we built VAR models in differences and calculate the impulse-response functions. Impulse response functions show the dynamic response of the system to a one period shock in one variable and give more dynamic detail than the Granger tests. Unit Root Testing The results for the unit-root tests are shown in Tables 1 and 2.
As expected for the early to period, traditional tests do not reject the null of a unit-root for the logarithm of money and of prices. In the tests that control for structural breaks, we cannot reject the hypothesis of unit roots. While the sequential DF test suggests the presence of changes both in the mean and slope of the trend in the two series, it does not reject the hypothesis of a unit root either.
In sum, we find strong evidence supporting the hypothesis that both money and prices are non-stationary processes. This result suggests that for this period the time series should be modeled as difference stationary processes where a random shock has a permanent effect on the economy. The results are shown in Table 2. For prices, there is strong evidence in all tests for rejecting the null hypothesis of a unit root and for not rejecting the hypothesis of no break.
This result does not surprise us and reflects the fact that during Convertibility prices stabilized and exhibited very low volatility. For money, the results among tests are not conclusive but two reasons lead us to think that money in this period might have followed a stationary process. In the first place, traditional test are powerful and reliable when rejecting the null hypothesis. Secondly, when choosing among the tests that control for structural breaks, the sequential DF is to be more reliable.
Using this last test, we find evidence of breaks both in the mean and the slope of the trend of the logarithm of money and we can reject the hypothesis of a unit root. Correlations and Graphical Analysis Table 3 shows the results of calculating simple pair wise correlations of log differences in money and log differences in prices. The correlation of current log differences in money with current log differences in prices, with lagged log differences in prices, and with leads of log differences in prices are given.
For any order of leads and lags, the highest correlations are encountered when we use twelve month moving averages. For the earlier period, the highest correlations of the twelve month moving averages are found when the log differences in prices lag log differences in money by two periods. For moving averages between 2 and 6 months, the highest correlations occur with one month lag in log differences in prices.
For the period of the currency board, the highest correlations of the twelve month moving averages are found when prices lead money by six periods. For some of the shorter moving averages, the highest correlations are found at shorter leads in prices and, in general, the number of leads increases with the number of periods included in the moving average. We construct a sequence of scatter plots for the leads or lags and the moving averages circled in Table 3.
This is our version of Lucas's filter. As can be seen Figures 2 and 3for both periods, as more months were included in the moving averages, the cloud in the graphs tends to concentrate on a line. It is clear from the figures that the relationship between log differences in prices and log differences in money is not the same for the two periods under analysis: It is worth mentioning that independent of which lag or lead in the log difference in price is used with the log differences in money, in all pairs the scatter diagram approaches a line as the number of moving averages is increased, the line has a 45 degrees for the earlier period and the line has a much smaller slope for the currency board period.
As mentioned earlier, the interesting result is that the intertemporal structure is very different for the two periods. In the first one, it seems that prices move before money as the best fit is the one taking two lags in priceswhile in the second one, money seems to precede prices as in this case the best fit is considering 6 leads in prices.
In order to provide additional evidence as to whether the intertemporal relationship is as described, Granger causality tests are conducted. Granger Causality Tests In line with the results found in the previous section with graph and correlation analysis, Granger causality tests between changes in money and prices show different conclusions for the two periods. In this period, prices Granger cause i. The detailed results are given in Annex 1.
These results are not the ones expected from traditional quantitative monetary theory nor from the empirical evidence of industrialized economies. The more standard result is that changes in money will result in changes in prices. However, during the early period, we found that changes in prices cause both from a Granger point of view and from the correlations changes in money.
We can think of two possible explanations, one based on rational expectations and forward looking behavior and the other based on fiscal dominance.
In developed countries, where money and prices exhibit low volatility, public expectations change slower than in the more volatile, developing economies. When changes in money and prices are smaller, the costs of monitoring become relatively more important and less monitoring is done.