Cointegration and a Test of the Quantity Theory of Money

FRB Richmond Working Paper No. 89-2

19 Pages Posted: 2 Nov 2012

See all articles by Yash P. Mehra

Yash P. Mehra

Federal Reserve Banks - Federal Reserve Bank of Richmond

Date Written: April 1, 1989

Abstract

The main implication of the Quantity Theory of Money is that long-run movements in the price level are determined primarily by long-run movements in the excess of money over real output. This implication is related to the concept of cointegration discussed in Granger (1986), which states cointegrated multiple time series share common long-run movements. It is shown that the general price level is cointegrated with money, real output, and the nominal rate of interest. These economic variables enter a price equation based on the Equation of Exchange. Furthermore, the appearance of this cointegration in the data seems consistent with the presence of Granger-causality from money and real output to the price level. It is also shown that an inflation equation that incorporates the above stated implication of the Quantity Theory of Money predicts quite well the actual behavior of inflation during the past decade or so. These results however hold for M2, not M1, measure of money.

Suggested Citation

Mehra, Yash P., Cointegration and a Test of the Quantity Theory of Money (April 1, 1989). FRB Richmond Working Paper No. 89-2, Available at SSRN: https://ssrn.com/abstract=2123550 or http://dx.doi.org/10.2139/ssrn.2123550

Yash P. Mehra (Contact Author)

Federal Reserve Banks - Federal Reserve Bank of Richmond ( email )

P.O. Box 27622
Richmond, VA 23261
United States
804-697-8247 (Phone)
804-697-8255 (Fax)

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