Working Paper: CEPR ID: DP126
Authors: Willem H. Buiter
Abstract: 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.
Keywords: Granger causality; policy effectiveness; rational expectations models
JEL Codes: 023; 026
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| policy instruments (x) (D78) | target variables (y) (C29) |
| x does not Granger-cause y (C29) | x can still be effective in controlling y (C53) |
| x (Y70) | y (Y60) |