Why U.S. Monoy ooos nol Causo U.S.

Oulpul,
Lul ooos Causo Hong Kong Oulpul

GaLiiol Iooiguoz
_
Univoisily of Ollawa
Nicholas Iowo
Cailolon Univoisily
Fiisl Diafl: May 10 1000
1his Voision: OcloLoi 11 2001
Devwudfw
Slanoaio oconomoliic losls foi wholhoi monoy causos oulpul will Lo
moaningloss if monolaiy policy is choson oplimally lo smoolh uclua-
lions in oulpul. If l.o. monolaiy policy woio choson lo smoolh l.o.
oulpul, wo show lhal l.o. monoy will nol Giangoi causo l.o. oulpul.
Inoooo, as shown Ly Iowo ano Yolman (2000), if lhoio is a (say) 6
quailoi lag in lho oocl of monoy on oulpul, lhon l.o. oulpul will Lo
unfoiocaslaLlo fiom any infoimalion sol availaLlo lo lho Foo laggoo 6
quailois. Lul if olhoi counliios, foi oxamplo Hong Kong, havo cui-
ioncios lhal aio nxoo lo lho l.o. oollai, Hong Kong monolaiy policy
will lhon Lo choson in Washinglon D.C., wilh no concoin foi smoolh-
ing Hong Kong oulpul. Lconomoliic causalily losls of l.o. monoy
on Hong Kong oulpul will lhon show ovioonco of causalily.. Wo losl
lhis ompiiically. Oui ompiiical analysis also piovioos a moasuio of lho
oogioo lo which maciooconomic slaLilisalion is saciicoo Ly aoopling a
nxoo oxchango ialo ialhoi lhan an inooponoonl monolaiy policy.
Nh|zrugv= Monolaiy Iolicy, Causalily, VLCM, U.S. Monoy, U.S.
Foooial Funos Ialo.
MHO Fodvvlfdwlrq= F6/ F8/ H7/ H81
W
Wo lhanks Jamos Yolman, Slovo Foiiis, Hunlloy Schalloi, ano Lhsan Chouohii foi
lhoii commonls ano suggoslions. 1hanks lo lho pailicipanls al lho sominai al Univoisily
of Cailolon. Iomaining oiiois aio lho aulhois` iosponsiLilily.
_
Aooioss foi coiiosponoonco: GaLiiol Iooiguoz, Univoisily of Ollawa, I.O. Lox 40,
Sln. A, Ollawa, Onlaiio, K1N 6N, Canaoa.
4 Lqwurgxfwlrq
Doos monoy causo ioal oulpul If lho Foooial Iosoivo woio suooonly, capii-
ciously, wilhoul waining, lo cul lho monoy supply Ly 20/, whal oocl
woulo lhis havo Noaily all macio-oconomisls woulo agioo lhal lho cul in
lho monoy supply woulo causo a fall in aggiogalo oomano, ano lhal lho
fall in aggiogalo oomano woulo causo, al loasl lompoiaiily, ioal oulpul lo
fall. 1ho only oisagioomonl woulo como fiom lho lwo oxliomo onos of lho
maciooconomic spoclium. Somo Iosl-Koynosian maciooconomisls woulo
aiguo lhal lho monoy supply has no oocl on aggiogalo oomano, ano so will
nol aocl ioal oulpul. Ano somo Classical macio-oconomisls woulo aiguo
lhal lho monoy supply mighl aocl aggiogalo oomano, Lul poifoclly oxiLlo
piicos ano wagos, ano lho iosulling voilical aggiogalo supply cuivo, woulo
moan lhal only lho piico lovol woulo fall, ano ioal oulpul woulo nol.
Dospilo lhis voiy gonoial agioomonl lhal monoy causos oulpul, lho sup-
poiling oconomoliic ovioonco is woak oi inconclusivo. Why is lhis 1ho
Lasic ioason foi lho woak oconomoliic ovioonco is simplo. 1ho soil of oxpoi-
imonl oosciiLoo aLovo is voiy unlikoly ovoi lo happon. 1ho Foooial Iosoivo,
Lolioving lhal a capiicious 20/ cul in lho monoy supply woulo havo oisas-
lious consoquoncos foi ioal oulpul, woulo nol willingly conoucl such an
oxpoiimonl. Il woulo nol capiiciously cul lho monoy supply Ly 20/ moioly
lo soo how Lig a iocossion lhis woulo causo. So lho soil of oxpoiimonl which
coulo piopoily losl wholhoi monoy causos oulpul is novoi in facl conoucloo.
1o say lho samo lhing anolhoi way, an OLS iogiossion of oulpul on monoy
will only givo unLiasoo oslimalos if lho monoy supply has a posilivo vaiianco
ano if monoy is oxogonous wilh iospocl lo oulpul. Lul oxogonoily of monoy
wilh iospocl lo oulpul woulo moan lhal lho Foooial Iosoivo choosos mono-
laiy policy wilhoul consiooiing lho oocl ils policy will havo on oulpul. No
iosponsiLlo Foooial Iosoivo woulo ovoi chooso monolaiy policy lhal way.
If monoy woio founo lo causo oulpul in an OLS iogiossion, lhis woulo
1
moan lhal lho Foo hao causoo oi poimilloo lho monoy supply lo vaiy in
such a way lhal lho vaiianco of oulpul was highoi lhan il woulo havo Loon
if lho Foo hao acloo oioionlly. Such a nnoing woulo Lo ovioonco nol
jusl lhal monoy causos oulpul, Lul lhal lho Foooial Iosoivo hao Lohavoo
iiiosponsiLly oi foolishly. A iosponsiLlo ano sonsiLlo Foo woulo novoi caiiy
oul lho soil of oxpoiimonl which woulo lol us oiioclly losl wholhoi monoy
causos oulpul.
1his pioLlom wilh losling wholhoi monoy causos oulpul is al ils slaikosl
whon lho Foo aoopls as ils ovoiiioing oLjoclivo lho goal of smoolhing oulpul
uclualions. Supposo lhoio is somo unooilying sliucluial oqualion, known
lo lho Foo, linking lovol of ioal oulpul 1
|n)
wilh lho lovol of monoy supply
`
|
, ano somo olhoi vaiiaLlos, wilh a j-poiioo lag in lho oocl of monoy on
oulpul:
1
|n)
= 1(`
|
, ....). (1)
1ho Foo iooally wanls ioal oulpul lo giow al somo conslanl suslainaLlo ialo
p. 1hon,
1
W
|n)
= p(t ). (2)
Assuming lho Foo has a symmoliic quaoialic loss funclion, ano lhal lho
sliucluio of lho oconomy is linoai, lho Foo will sol lho monoy supply in oach
poiioo so lhal lho ialional oxpoclalion of ioal oulpul in t , conoilional
on all infoimalion availaLlo al limo t (1
|
) oquals lho iooal lovol:
1(1
in)
m1
|
) = 1(1(`
|
, .....)m1
|
) = 1
W
|n)
. (8)
Any vaiiaLlo can Lo oocomposoo inlo ils ialional oxpoclalion ano a foiocasl
oiioi, whoio lhal foiocasl oiioi musl Lo uncoiiolaloo wilh anylhing in lho
infoimalion sol al limo t. 1hon,
1
|n)
= 1(1
|n)
m1
|
) c
|n)
. (4)
SuLsliluling fiom (2) ano (8) inlo (4) wo gol
1
|n)
= p(t ) c
|n)
. ()
2
Whal oqualion () says is lhal oulpul will oqual a limo liono plus a ianoom
oiioi which is lolally uncoiiolaloo wilh any infoimalion availaLlo al limo t.
IiosumaLly lho monoy supply is pail of lhal infoimalion sol. 1his moans
lhal if lho Foooial Iosoivo is using monolaiy policy lo smoolh ioal oul-
pul, oulpul will nocossaiily Lo uncoiiolaloo wilh lho laggoo monoy supply.
Lvon lhough Ly assumplion monoy causos oulpul, wilh a j-poiioo lag, any
oconomoliic causalily losl will nno no ovioonco foi causalily.
1o unooislano lhis iosull Lolloi, lol us ask unooi whal ciicumslancos
lho Foooial Iosoivo woulo chooso lo cul lho monoy supply Ly 20/. Il
woulo oo lhis only if il loainoo somo infoimalion (aLoul ono of lho olhoi
vaiiaLlos in lho sliucluial oqualion 1(.), liko a majoi lax cul foi oxamplo)
which woulo loao il lo oxpocl a Lig incioaso in oulpul if il holo lho monoy
supply conslanl. If lho Foo foiocasls coiioclly, lho monoy supply will fall
Ly 20/, Lul oulpul will conlinuo lo giow al liono. 1ho only uclualions
in oulpul will Lo lho iosull of lho Foo`s foiocasl oiiois, ano lhoso shoulo Lo
uncoiiolaloo wilh anylhing lho Foo knows al lho limo whon ils monolaiy
policy can inuonco oulpul.
In oiooi lo losl wholhoi monoy causos oulpul wo havo lo nno a oala sol
whoio lho monolaiy aulhoiily vaiios lho monoy supply wilh no concoin foi
ils oocl on oulpul. Hong Kong piovioos jusl such a oala sol. Foi many
yoais, Hong Kong has mainlainoo appioximaloly nxoo oxchango ialos wilh
lho U.S. oollai. Sinco Hong Kong is small iolalivo lo lho U.S., ano sinco lho
Foooial Iosoivo unooilakos no iosponsiLilily lo holp Hong Kong mainlain
lho nxoo oxchango ialo, Hong Kong monolaiy policy is ooclivoly sol in
Washinglon D.C. If lho shocks lo lho U.S. ano Hong Kong oconomios aio
impoifoclly coiiolaloo, ano if lho Foooial Iosoivo conoucls monolaiy policy
lo smoolh U.S. oulpul, Lul ooos nol caio aLoul Hong Kong oulpul, lhis
moans lhal monolaiy policy is al loasl pailly oxogonous wilh iospocl lo
Hong Kong oulpul.
Supposo lho Foo soos a posilivo shock aLoul lo hil lho U.S. oconomy. Il
8
lowois lho monoy supply in oiooi lo loan againsl lho wino ano osol lhis
shock. If ils foiocasl is succossful, U.S. oulpul conlinuos lo giow al liono.
Lul if no similai shock hils lho Hong Kong oconomy, Hong Kong will Lo
hil Ly lho full impacl of lho cul in U.S. monoy supply, wilh no osolling
shock, ano will suoi a iocossion. Similaily, if lho Foo anlicipalos a nogalivo
shock lo lho U.S. oconomy, il will iaiso lho monoy supply. No chango in
U.S. oulpul is suLsoquonlly oLsoivoo, Lul Hong Kong onjoys a Loom
1
.
1hus, if lho Foooial Iosoivo is smoolhing U.S. oulpul, Lul is nol con-
coinoo aLoul Hong Kong oulpul, ano if olhoi shocks lo lho U.S. ano Hong
Kong oconomios aio impoifoclly coiiolaloo, U.S. monoy will Lo soon lo
Giangoi-causo Hong Kong oulpul, Lul nol lo Giangoi-causo U.S. oulpul.
5 Hpslulfdo Dssolfdwlrq
In lhis soclion wo piosonl lho ompiiical ovioonco fiom lho causalily losls.
Oui oala consisl of lho vocloi . of oimonsion : Ly 1 which conlains lho
lhioo limo soiios usoo in lho suLsoquonl analysis. 1hal is, .
|
= (j
|
, j
2|
, j
|
)

,
whoio j
|
oonolos lho logaiilhm of lho oulpul of Hong Kong (j
II
|
); j
2|
oonolos lho logaiilhm of lho oulpul of US (j
&c
|
); ano j
|
oonolos oilhoi lho
logaiilhm of lho US monoy supply (:
&c
|
) oi lho lovol of lho US Foooial Funo
Ialo (1
&c
|
). 1ho oala is quailoily ano il spans fiom 1086:1 unlil 1000:4.
1ho ompiiical applicalion lhal follows consisls of lhioo slops. In lho nisl
slop, wo losl foi lho oiooi of inlogialion of oach limo soiios, using lho univaii-
alo augmonloo Dickoy Fulloi (11) unil iool losl (Dickoy ano Fulloi, 1070,
Saio ano Dickoy, 1084). In socono slop, wo losl foi lho oxislonco of coinlo-
1
Oui sloiy hoio assumos lho shock lo lho U.S. oconomy is an IS shock. A posilivo IS
shock lo lho U.S. oconomy moans lho Foo will ioouco lho monoy supply ano iaiso inloiosl
ialos lo holo U.S. aggiogalo oomano conslanl. Lul lho highoi U.S. inloiosl ialos will moan
highoi Hong Kong inloiosl ialos also, pioviooo lhoio is al loasl somo capilal moLilily. Ano
lho highoi Hong Kong inloiosl ialos will ioouco aggiogalo oomano in Hong Kong (unloss
Hong Kong happons lo faco a similai posilivo IS shock). If lho shock lo lho U.S. oconomy
woio an LM shock, such as a fall in U.S. monoy oomano, lho Foo woulo ioouco lho monoy
supply piopoilionaloly, loaving inloiosl ialos unchangoo, ano lhoio woulo Lo no oocl in
oilhoi counliy.
4
gialion iolalions using lho Johanson piocoouio (Johanson (1088)). In lho
lhiio ano lasl slop, wo oslimalo lho vocloi oiioi coiioclion moool (\ 1C`)
ano losl foi Giangoi causalily using lho iocommonoalions of Ihillips ano
1ooa (1004). In facl, lho appiopiialo way lo losl foi causalily ooponos on
wholhoi oi nol lhoio oxisl coinlogialing iolalions. Whon lhoio aio coinlo-
gialion iolalions, wo can losl foi shoil iun causalily using an 1 losl of lho
signincanco of lho laggoo oioioncos of lho iolovanl vaiiaLlos (in oui caso,
^:
&c
|3I
oi ^1
&c
|3I
foi / = 1, 2, .../
W
). Ano wo can losl foi long iun causalily
Ly, in aooilion, using an 1 losl of lho signincanco of lho oiioi coiioclion
loim. Somo ompiiical iofoioncos aio Khalio ano Guan (1000), Woinoihoim
(2000), Hayo (1000).
1aLlo 1 shows iosulls fiom lho applicalion of 11 losl. 1ho lag longlh
was choson using lho soquonlial piocoouio suggosloo Ly CampLoll ano Ioi-
ion (1001) which consisls of inilially assuming somo maximal lag (say /:aa)
in lho oslimalion of lho 11 auloiogiossion ano losling foi lho signincanco
(al 00/) of lho lasl lag. If no signincanco is founo, lho slalislic is again
oslimaloo using /:aa1 lags. 1ho piocoouio is iopoaloo unlil a signincanl
lag is founo. If no signincanl lag is founo, wo chooso / = 0.
Iosulls in 1aLlo 1 show ovioonco of nonslalionaiily foi all soiios. In
olhoi woios, all soiios can Lo consiooioo as 1(1) piocossos. Givon lhis facl,
oui socono slop is lo liy lo voiify lho oxislonco of coinlogialion iolalions
Lolwoon lho sol of vaiiaLlos.
1ho piosonco of coinlogialion was voiinoo using lho mullivaiialo pio-
coouio pioposoo Ly Johanson (1088). Soo also Johanson (1001, 100) ano
Johanson ano Jusolius (1000). 1his losl usos lho following \ 1C` iopio-
sonlalion:
^j
|
= I

^j
|3
I
2
^j
|32
... I
j
^j
|3jn
Hj
|3
d
|
c
|
(6)
whoio
1(c
|
) = 0 (7)

1(c
|
c
t
) =

\ t = t
0 ot/crni-c

In lho oxpiossion (6), lho maliix H conlains lho infoimalion on lho possiLlo
coinlogialion iolalions Lolwoon lho : olomonls of j
|
. 1ho oqualion (6) oois
lhioo possiLlo casos accoioing lo lho iank of lho maliix H. Fiisl, lho maliix
H can Lo lho zoio-maliix, which implios lhal lho iank of H oquals 0. Socono,
lho maliix H can havo full iank :. 1hiio, lho maliix H can havo iank
ooncioncy, lhal is 0 < ra:/(H) < :, ano in lhis caso, lhis maliix can Lo
oocomposoo as H = cu

, whoio c ano u aio (: Ly r) maliicos. 1ho maliix

u conlains lho r coinlogialing iolalions whilo lho maliix c conlains lho
aojuslmonl paiamolois.
1ho Johanson maximum likolihooo coinlogialion losling molhoo aims
lo losl lho iank of lho maliix H in (6) using lho iooucoo iank iogiossion
lochniquo Lasoo on canonical coiiolalions. Soo Fiansos (1000) oi Johanson
(100) foi a Liiof oi moio complolo oosciiplion of lhis appioach. Assuming
lhal lho inloicopls aio nol iosliicloo, lho piocoouio consisls of oLlaining an
: Ly 1 vocloi of iosiouals r
f|
ano r
|
fiom lho so calloo auxiliaiy iogiossions
(iogiossions of ^j
|
ano j
|3
on a conslanl ano lho laggoo ^j
|3
lhiough
^j
|3jn
). 1hoso iosiouals aio usoo lo oLlain lho (: Ly :) iosioual piooucl
maliicos
2
:
o
i)
= (1T)
T
[
|'
r
i|
r

i|
, i, = 0, 1 (8)
1ho noxl slop is lo solvo lho oigonvaluo pioLlom
m`o

o
f
o
3
ff
o
f
m = 0 (0)
which givos lho oigonvaluos
e
`

N ... N
e
`
a
ano lho coiiosponoing oigonvoclois
e
u

lhiough
e
u
a
. A losl foi lho iank of lho maliix H can now poifoimoo Ly
losling how many oigonvaluos ` oquals unily. 1ho nisl losl slalislic foi lho
2
Of couiso sliglhly oioionl auxiliaiy iogiossion havo lo Lo oslimaloo if lho inloicopls
aio iosliicloo oi lhoy aio consiooioo zoio, foi oxamplo.
6
iosulling numLoi of coinlogialion iolalions is lho so calloo 1iaco slalislic
(soo Johanson, 1088), which is a likolihooo ialio losl oonnoo Ly
Tracc = T
a
[
i'vn
|op(1
e
`
i
) (10)
1ho null hypolhosis foi lhis Tracc losl is lhal lhoio aio al mosl r coinlogia-
lion iolalions. Wo Login Ly losling wholhoi lhoio is no coinlogialion (r = 0)
voisus al mosl 1 such iolalion. If lhis is iojocloo, wo losl wholhoi lhoio aio
al mosl lwo coinlogialion iolalions ano so on. Anolhoi usoful losl is givon
Ly losling lho signincanco of lho oslimaloo oigonvaluos lhomsolvos
`
4@
= T|op(1
e
`
i
) (11)
which can Lo usoo lo losl lho null hypolhosis of r 1 againsl r coinlogialion
iolalions.
Ciilical valuos foi lhoso losls havo Loon laLulaloo Ly Osloiwalo-Lonum
(1002). Howovoi, limiling oisliiLulions oopono on lho sol of ooloiminislic
compononls consiooioo in oqualion (6) ano oopono also on lho sol of oo-
loiminislic compononls allowoo in lho coinlogialing iolalions. Givon lho
naluio of oui soiios, wo always consiooi an inloicopl in lho \ 1C` oslima-
lion. Foi lho coinlogialion iolalions, wo consiooi lwo casos. 1ho nisl caso
incluoos only an inloicopl in lho long iun iolalionship. In lho socono caso,
wo incluoo an inloicopl ano also a limo liono in lho long iun oqualion. In
lho laLlos, wo iofoi lo lho foimoi as lho nisl spocincalion" ano lho lalloi
as lho socono spocincalion".
Anolhoi impoilanl issuo, in lho applicalion of lho Johanson losl, is lho
spocincalion of lho lag longlh. Many suggoslions appoai in lho liloialuio.
Ono suggoslion is lo uso infoimalional ciiloiia such as 1C oi o1C.
8
Givon
lhal oui goal is lo ioonlify causalily, wo aio pailiculaily inloiosloo in somo
8
Anolhoi suggoslion is lo uso lho likolihooo ialio losl, Lasoo oilhoi on lho log valuo of
lho likolihooo oi Lasoo on lho ooloiminanl of lho covaiianco maliix. Wo oiscovoioo lhal
lhis losl gavo us ossonlially lho samo iosulls as lho U
7
longoi lag spocincalion. Honco, lho o1C piocoouio is nol consiooioo, Lo-
causo il is known lhal lhis ciiloiia will chooso a moio paisimonious moool.
Using 1C, wo havo solocloo / = 8 foi lho spocincalion in lovols, which
implios using / = 7 in lho \ 1C` spocincalion.
1ho iosulls fiom lho applicalion of lho Johanson losl aio shown in 1aLlos
2a ano 2L. 1hoio is cloai ovioonco of coinlogialion in all sysloms. Using lho
U.S. Foooial Funos ialo as lho monolaiy insliumonl iovoals ono coinlogia-
lion iolalionship using lho nisl spocincalion, ano lwo coinlogialion iolalions
in lho socono spocincalion. Using lho U.S. monoy supply as lho monolaiy
insliumonl iovoals lwo coinlogialion iolalions in lho socono spocincalion.
Nolico howovoi, lhal in lho nisl spocincalion wo founo r = 8, which implios
lhal all vaiiaLlos aio slalionaiy. 1his iosull mighl Lo a consoquonco of lho
small samplo sizo usoo in lho applicalion. In facl, lhoio is ovioonco (soo
Maooala ano Kim (1000) foi a suivoy) lhal small samplos can causo spuii-
ous iojoclion of lho null hypolhosis of no coinlogialion. Ono iocommonooo
solulion foi lhis pioLloms lo aojusl lho valuos of lho slalislics lo lako inlo
accounl small samplo sizo. Wo oo lhis only in lho caso whoio r = 8. Follow-
ing Ioimois (1002), wo aojusloo lho `
4@
losl Ly (T /:)T, whoio T is
lho lolal numLoi of oLsoivalions, / is lho lag numLoi ano : is lho numLoi
of vaiiaLlos usoo in lho syslom. Wilh lhis aojuslmonl, lho valuos foi lho
`
4@
losl aio 21.70, 11.18 ano 6.21. Only lho nisl of lhoso is signincanl al
0.0/. Honco, wo will woik wilh r = 1.
Oui lhiio ano nnal slop is lo oslimalo lho \ 1C` in oiooi lo losl foi
causalily fiom lho monolaiy insliumonls lo oulpul. 1ho oqualions lo Lo
oslimaloo aio:
^j
i
|
=
I
[
I'
a
I
^j
i
|3I

I
[
I'
/
I
^j
)
|3I

I
[
I'
c
I
^1
&c
|3I

v
[
c'
d
c
cct
c
|3
c

2
1
2

c
|
(12)
8
^j
i
|
=
I
[
I'
a
I
^j
i
|3I

I
[
I'
/
I
^j
)
|3I

I
[
I'
c
I
^:
&c
|3I

v
[
c'
d
c
cct
c
|3
c

2
1
2

c
|
(18)
whoio i = Ho:p 1o:p ano = lo; cct
|3
coiiosponos lo lho oiioi coiioc-
lion loim; 1
i
is a soasonal oummy vaiiaLlo oonnoo as 1
i
= 1 foi i = 1, 2, 8
quailois. Lqualions (12) ano (18) consiooi lho US Foooial Funos Ialo (1
&c
|
)
ano US monoy supply (:
&c
|
) as lho monolaiy insliumonls, iospoclivoly.
Iosulls using lho Foooial Funos Ialo as lho insliumonl monolaiy aio
shown in 1aLlo 8a, ano lho iosulls using lho monoy supply as lho mono-
laiy insliumonl aio shown in 1aLlo 8L. Wo piosonl lho valuo of lho 1losl
(wo incluoo in paionlhosos lho associaloo p-valuo), unooi Lolh lho nisl ano
socono spocincalions usoo in lho coinlogialion analysis. Ovoiall, oui piin-
cipal conclusion is cloai, ano is also ioLusl lo wholhoi lho Foooial Funos
Ialo oi lho monoy supply is lioaloo as lho monolaiy insliumonl. 1hoio is
cloai ovioonco in favoi of oui hypolhosis lhal U.S. monolaiy policy causos
Hong Kong oulpul, Lul ooos nol causo U.S. oulpul. Whon lho 1-losl in-
cluoos losling foi lho oiioi coiioclion loims, lho iosulls givo ovon sliongoi
ovioonco in favoi of long iun causalily fiom U.S. monolaiy policy lo Hong
Kong oulpul.
Nolico, howovoi, lhal oui iosulls fiom Giangoi causalily losls nooo lo Lo
consiooioo wilh caulion Locauso of lho small samplo sizo usoo in lho appli-
calions. Ihillips ano 1ooa (1004) show, Lasoo in Monlo Cailo simulalions,
lhal il is oimcull lo suppoil valioily of lho 1-losl whon samplo sizos aio
small ano whon lhioo oi moio vaiiaLlos aio usoo in lho syslom.
If all valuos of lho Johanson losl aio aojusloo using lho iulo suggosloo foi
Ioimois (1002), wo havo ovioonco in favoi of r = 1 only foi lho caso whoio
U.S. monoy is usoo as monolaiy insliumonl ano using oui nisl spocincalion.
In all olhoi casos, coinlogialion is no longoi founo. In lhoso casos, wo can
0
losl foi Giangoi causalily using lho slanoaio fiamowoik. Oui oslimalions
4
show lhal lhoio is no causalily fiom US monolaiy insliumonl lo Hong Kong
oulpul ano U.S. oulpul.
Docomposilion of vaiianco can Lo usoo lo moasuio lho impoilanco of
ono shock in lho oxplanalion of lho vaiianco oiioi. Wo piosonl lhoso iosulls
only foi lho caso whoio U.S. monoy is usoo as monolaiy insliumonl using
oui nisl spocincalion. IomomLoi lhal in lhis caso r = 1 was founo. Iosulls
aio piosonloo in 1aLlo 4 ano lhoy aio nol sonsilivo lo lho oiooi of lho
vaiiaLlos usoo lo oslimalo lho \ 1C`

. 1aLlo 4 shows lhal lho vaiianco

oiioi of lho Hong Kong oulpul is oxplainoo al lho ono of lho lhiio yoai
(an hoiizon oqual lo 12 quailois) aiouno 8./ foi U.S. oulpul ano 26.4/
foi U.S. monoy. Using a hoiizon of 24 quailois lhoso valuos aio 48.6 ano
17.6/, iospoclivoly. Whon lho vaiianco oiioi of U.S. oulpul oi U.S. monoy
aio analyzoo, wo soo a oioionl picluio: Hong Kong oulpul has no shoil oi
long iun oocls on U.S. oulpul. Lul moio impoilanlly, U.S. monoy is nol
aLlo lo oxplain lho vaiianco oiioi of lho U.S. oulpul. 1his is in concoioanco
wilh oui causalily analysis.
6 Frqfoxvlrq
1his papoi shows lhal U.S. monolaiy policy ooos nol causo U.S. oulpul, Lul
ooos causo Hong Kong oulpul. 1o show lhis, wo usoo lho Giangoi causalily
losl in lho conloxl of coinlogialion, as was suggosloo Ly Ihillips ano 1ooa
(1004). Locauso lho samplo sizo usoo is voiy small, oui iosulls havo lo Lo
inloipioloo wilh caulion. Howovoi, all iosulls connim lho nnoing lhal lho
U.S. monolaiy insliumonl (l.o. Foooial Funos Ialo oi l.o. monoy supply)
aocls ioal oulpul in Hong Kong Lul has no oocl on U.S. oulpul.
How is il lhal U.S. monolaiy policy coulo appoai lo havo no ioal oocls
4
1hoy aio nol iopoiloo hoio Lul lhoy can Lo oLlainoo upon ioquosl.

Oilhogonalisalion of lho oisluiLancos is poifoimoo using Choloski oocomposilion. Wo

voiinoo all possiLlo oioois of vaiiaLlos in lho T . oslimalion ano no suLslanlial changos
woio oLsoivoo. Iosulls aio availaLlo upon ioquosl.
10
al homo, Lul lo havo Lig ioal oocls on lho opposilo sioo of lho woilo
Oui iosolulion of lhis paiaoox is simplo. U.S. monolaiy policy is choson lo
smoolh U.S. oulpul, ano so uclualions of U.S. oulpul fiom liono iopio-
sonl lho Foo`s foiocasl oiiois, which musl unooi ialional oxpoclalions Lo
oilhogonol lo lho Foo`s infoimalion sol al lho conliol lag, ano lhis infoima-
lion sol incluoos lho monolaiy insliumonl. No Giangoi losl coulo ovoi show
lhal an oxogonous chango in U.S. monolaiy policy woulo causo a chango in
U.S. oulpul, Locauso U.S. monolaiy policy is choson spocincally lo avoio
making oxogonous changos which woulo causo U.S. oulpul lo uclualo. Lul
lhis ooos nol moan lhal U.S. monolaiy policy is iiiolovanl foi ioal vaiiaLlos.
1ho facl lhal Hong Kong oulpul is sliongly inuoncoo Ly an oxogonous (lo
Hong Kong) U.S. monolaiy policy suioly implios lhal U.S. oulpul woulo
also Lo sliongly inuoncoo if U.S. monolaiy policy woio, counloifaclually,
oxogonous lo lho U.S.
Oui iosolulion of lho paiaoox is simplo ano, wo Loliovo, plausiLlo. No
olhoi iosolulion appoais ioasonaLlo. Il woulo nol Lo ioasonaLlo lo aiguo, foi
oxamplo, lhal lho U.S. has poifoclly oxiLlo piicos ano lhoiofoio monoy is
noulial in lho U.S., whilo Hong Kong has slicky piicos ano lhoiofoio monoy
is nol noulial in Hong Kong. If oui iosolulion of lho paiaoox is accoploo, lhis
moans lhal all piovious ompiiical losls foi lho ioal oocls of monolaiy policy
aio oooply awoo, ano massivoly unooioslimalo lho impoilanco of monolaiy
policy foi ioal vaiiaLlos. 1ho facl lhal il is so haio lo show ompiiically
lhal U.S. monolaiy policy has ioal oocls in lho U.S. ooos nol inoicalo lho
iiiolovanco of monolaiy policy. Insloao il shows lhal lho Foooial Iosoivo
has nol managoo monolaiy policy lo mako lho monoy supply uclualo liko
lho woalhoi. Inoooo, a sliong nnoing lhal monoy oio Giangoi causo oulpul
woulo Lo gooo giounos foi oomanoing lho iosignalion of lho Chaiiman of
lho Foooial Iosoivo.
11
Uhihuhqfhv
[1[ CampLoll, J. Y. ano I. Ioiion (1001), Iilfalls ano Oppoilunilios: Whal
Maciooconomisl Shoulo Know ALoul Unil Iools, in O. J. Llanchaio
ano S. Fischoi (oos.), QEHU Pdfurhfrqrplfv Dqqxdo, yro1 9, 141-201.
[2[ Dickoy, D. A. ano W. A. Fulloi (1070), DisliiLulion of lho Lslimaloi foi
Auloiogiossivo 1imo Soiios wilh a Unil Iool, Mrxuqdo ri wkh Dphulfdq
Vwdwlvwlfdo Dvvrfldwlrq :7, 427-481.
[8[ Fiansos, I. H. (1008), 1imo Soiios Moools foi Lusinoss ano Lconomic
Foiocasling, CamLiiogo Univoisily Iioss.
[4[ Hayo, L. (1000), Monoy-Oulpul Giangoi Causalily Iovisiloo. An Lm-
piiical Analysis of LU Counliios, inooil manusciipl.
[[ Johanson, S. (1088), Slalislical Analysis of Coinlogialion Voclois, Mrxu0
qdo ri Hfrqrplfv G|qdplfv dqg Frqwuro 45, 281-24.
[6[ Johanson, S. (1001), Lslimalion ano Hypolhosis 1osling of Coinlogia-
lion Voclois in Gaussian Vocloi Auloiogiossivo Moools, Hfrqrphwulfd
8<, 11-180.
[7[ Johanson, S. (100), Likolihooo-Lasoo Infoionco In Coinlogialoo Vocloi
Aulo-Iogiossivo Moools, Oxfoio Univoisily Iioss.
[8[ Johanson, S. ano K. Jusolius (1000), Maximum Likolihooo Lslimalion
ano Infoionco on Coinlogialion - wilh Applicalions lo lho Domano foi
Monoy, R{irug Exoohwlq ri Hfrqrplfv dqg Vwdwlvwlfv 85, 160-210.
[0[ Khalio, A. ano D. Guan (1000), Causalily 1osls of Luogol ano Cuiionl
Accounl Docils: Cioss-Counliy Compaiison, Hpslulfdo Hfrqrplfv 57,
880-402.
[10[ Maooala, G. S. ano I. M. Kim (1000), Unil Iools, Coinlogialion, ano
Sliucluial Chango, CamLiiogo Univoisily Iioss.
12
[11[ Osloiwalo-Lonum, M. (1002), A Nolo wilh Fiaclilos of lho Asymplolic
DisliiLulion of lho Maximun Likolihooo Coinlogialion Iank 1osl Sla-
lislics: Foui Casos, R{irug Exoohwlq ri Hfrqrplfv dqg Vwdwlvwlfv 87,
461-472.
[12[ Ihillips, I. C. L. ano H. Y. 1ooa (1004), Vocloi Auloiogiossion ano
Causalily: a 1hooiolical Ovoiviow ano Simulalion Sluoy, Hfrqrphwulf
Uhylhzv 46(2), 20-28.
[18[ Ioimois, H. L. (1002), Compaiisons of 1osls foi Mullivaiialo Coinlo-
gialion, Vwdwlvwlfdo Sdshuv 66, 88-80.
[14[ Iowo, N. ano J. Yolman (2000) Ioonlifying Iolicy-makois OLjoclivos:
An Applicalion lo lho Lank of Canaoa Lank of Canaoa Woiking Iapoi
2000-11.
[1[ Saio, S. L. ano D. A. Dickoy (1070), 1osling foi Unil Iools in Auloio-
giossivo Moving Avoiago Moools of Unknown Oiooi, Elrphwulnd :4,
00-608.
[16[ Woinoihoim, C. M. (2000), Coinlogialion ano Causalily in lho Lxpoils-
GDI Noxus: Iosl-Wai Lvioonco foi Canaoa, Hpslulfdo Hfrqrplfv 58,
111-12.
18
1aLlo 1. ADF losl
Soiios 11 / e c Doloiminislic compononls
j
II
|
-2.086 0.82 d
|
= i1, tj
j
&c
|
-0.708 2 0.060 d
|
= i1, tj
:
&c
|
-2.82 0.880 d
|
= i1, tj
1
&c
|
-1.878-8.100 1 0.0400.86 d
|
= i1jd
|
= i1, tj
14
1aLlo 2a. Coinlogialion `
4@
1osl
Soiios H
f
H

Fiisl spocincalion Socono spocincalion

Inloicopl only Inloicopl ano limo liono
j
II
|
, j
&c
|
, :
&c
|
r = 0 r = 1 88.8
o
88.8
o
r = 1 r = 2 14.8
b
10.70
b
r = 2 r = 8 7.00
o
11.08
j
II
|
, j
&c
|
, 1
&c
|
r = 0 r = 1 20.46
o
82.74
o
r = 1 r = 2 18.8 28.47
o
r = 2 r = 8 1.02 8.0
a, / oonolo signincanco lovol al 00.0/ ano 0.0/, iospoclivoly.
1aLlo 2L. Coinlogialion Tracc 1osl
Soiios H
f
H

Fiisl spocincalion Socono spocincalion

Inloicopl only Inloicopl ano limo liono
j
II
|
, j
&c
|
, :
&c
|
r = 0 r " 0 0.87
o
60.40
o
r 1 r " 1 21.20
o
80.82
b
r 2 r " 2 6.71
o
11.08
j
II
|
, j
&c
|
, 1
&c
|
r = 0 r " 0 44.27
o
70.18
o
r 1 r " 1 14.81 87.47
o
r 2 r " 2 1.02 8.0
a, / oonolo signincanco lovol al 00.0/ ano 0.0/, iospoclivoly.
1
1aLlo 8a. Causalily losls using 1
&c
|
as lho monolaiy insliumonl
^j
i
|
=
S
I
I'
a
I
^j
i
|3I

S
I
I'
/
I
^j
)
|3I

S
I
I'
c
I
^1
&c
|3I

S
v
c'
d
c
cct
c
|3
c

2
1
2

c
|
Doponoonl VaiiaLlo Fiisl spocincalion Socono spocincalion
Inloicopl only Inloicopl ano limo liono
1 Tc-t (j a|nc) 1 Tc-t (j a|nc)
c
I
= 0 c
I
= 0, d
c
= 0 c
I
= 0 c
I
= 0, d
c
= 0
^j
II
|
/ = 1, ..., 7 1.70(0.141) 2.04(0.00) 1.74(0.1) 8.21(0.01)
/ = 2, ..., 7 2.00(0.00) 2.82(0.06) 2.08(0.10) 8.60(0.01)
/ = 8, ..., 7 2.1(0.16) 2.68(0.04) 2.42(0.07) 4.00(0.00)
/ = 4, ..., 7 8.0(0.04) 8.22(0.02) 8.00(0.04) 4.77(0.00)
/ = , ..., 7 8.22(0.04) 8.84(0.02) 8.27(0.04) .8(0.00)
/ = 6, 7 1.06(0.16) 4.87(0.01) 2.00(0.16) 6.10(0.00)
/ = 7 8.82(0.06) .8(0.01) 8.86(0.06) 7.10(0.00)
^j
&c
|
/ = 1, ..., 7 0.88(0.01) 0.8(0.04) 0.40(0.88) 0.74(0.66)
/ = 2, ..., 7 0.86(0.88) 0.8(0.02) 0.48(0.81) 0.70(0.61)
/ = 8, ..., 7 0.80(0.88) 0.84(0.00) 0.(0.74) 0.84(0.6)
/ = 4, ..., 7 0.48(0.78) 0.40(0.84) 0.64(0.64) 0.08(0.46)
/ = , ..., 7 0.6(0.67) 0.0(0.74) 0.8(0.48) 1.16(0.86)
/ = 6, 7 0.81(0.48) 0.66(0.8) 1.26(0.80) 1.4(0.2)
/ = 7 1.62(0.2) 0.08(0.80) 2.2(0.18) 1.08(0.1)
16
1aLlo 8L. Causalily losls using :
&c
|
as lho monolaiy insliumonl
^j
i
|
=
S
I
I'
a
I
^j
i
|3I

S
I
I'
/
I
^j
)
|3I

S
I
I'
c
I
^:
&c
|3I

S
v
c'
d
c
cct
c
|3
c

2
1
2

c
|
Doponoonl VaiiaLlo Fiisl spocincalion Socono spocincalion
Inloicopl only Inloicopl ano limo liono
1 Tc-t (j a|nc) 1 Tc-t (j a|nc)
c
I
= 0 c
I
= 0, d
c
= 0 c
I
= 0 c
I
= 0, d
c
= 0
^j
II
|
/ = 1, ..., 7 2.10(0.07) 2.86(0.02) 2.40(0.06) 4.24(0.00)
/ = 2, ..., 7 2.18(0.00) 8.28(0.02) 2.08(0.10) 4.78(0.00)
/ = 8, ..., 7 2.40(0.06) 8.72(0.01) 2.42(0.07) .84(0.00)
/ = 4, ..., 7 8.10(0.04) 4.21(0.01) 2.06(0.04) .0(0.00)
/ = , ..., 7 0.74(0.4) 8.8(0.02) 1.00(0.41) .66(0.00)
/ = 6, 7 1.00(0.8) 4.06(0.02) 1.40(0.27) 6.01(0.00)
/ = 7 1.2(0.28) .40(0.01) 2.11(0.16) 7.41(0.00)
^j
&c
|
/ = 1, ..., 7 0.67(0.60) 0.0(0.77) 0.72(0.6) 0.88(0.60)
/ = 2, ..., 7 0.7(0.62) 0.64(0.72) 0.78(0.0) 0.00(0.8)
/ = 8, ..., 7 0.80(0.0) 0.7(0.62) 0.08(0.48) 1.08(0.44)
/ = 4, ..., 7 0.06(0.4) 0.70(0.7) 0.08(0.46) 1.10(0.80)
/ = , ..., 7 1.28(0.80) 0.07(0.44) 1.18(0.84) 1.82(0.20)
/ = 6, 7 0.84(0.72) 0.42(0.74) 0.81(0.74) 0.04(0.46)
/ = 7 0.12(0.78) 0.07(0.08) 0.11(0.74) 0.86(0.47)
17
1aLlo 4. Vaiianco Docomposilion
Liioi Vaiianco of ConliiLulion fiom Hoiizon (in quailois)
/ = 1 / = 6 / = 12 / = 24
j
II
100.0 62.7 88.1 88.7
j
II
j
&c
0.0 12.4 8. 48.6
:
&c
0.0 24.8 26.4 17.6
j
II
2.8 1. 8.8 8.
j
&c
j
&c
07.2 04.2 01.0 04.2
:
&c
0.0 4. 4.8 2.8
j
II
0.7 14.8 14.6 21.0
:
&c
j
&c
1.8 8.7 17.4 8.1
:
&c
88. 76. 67.0 20.8
18