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

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.