Many theories about money, interest rates and prices are discussed. A diversity of opinion exists as to whether there are any causal relationships between these variables. Econometric techniques for testing causality are still being improved. This paper uses multivariate time series model to analyze the causality that might exist between these three variables.
The following are some of the theories that deal with causalities.
(a) The money supply causes prices to change:
Quantity theory, demand-pull inflation, etc.
(b) Prices cause the quantity of money to change:
Accommodation hypothesis, Price-specie-flow mechanism, policy manipulation, etc.
(c) The money supply causes the interest rates to change:
the Income effect, Price expectation effect, Liquidity effect, etc.
(d) The interest rates cause the quantity of money to change:
New-view money supply theory.
(e) Prices cause the interest rates to change:
Fisher effect, Mundell effect, etc.
(f) The interest rates cause prices to change:
Mark-up effect, Fama effect, cost-push inflation, etc.
Monthly data from January 1978 to December 1984 were collected for the purposes of the study. The following results are derived:
(1) A rise in MIA will result in an increase in prices with a lag of about one year. MIB and M2 will not cause prices to rise significantly.
(2) A rise in the interest rate will push up the price level in the short term.
(3) Interest rates are not influenced significantly by the money supply and price level.
(4) The Quantity theory, Fama effect and Mark-up effect are supported by our findings.
(5). The accommodation hypothesis, Liquidity effect, New-view money supply theory, Fisher effect and Mundell effect, etc., are not supported empirically in this paper.
