A Test of Granger Causality between Internal and External Imbalances: The Case of China, Japan and United States

Abstract

This paper develops an econometric model to examine the casual relationship between internal and external imbalances using yearly data for China, Japan and United States ranges from1970 to 2008. Johansen Cointegration test reveals the presence of long-run equilibrium relationship among variables. The Granger non-causality test based on vector error correction model (VECM) indicates that: 1) the Japanese internal imbalance Granger causes that of China, with a short-run substitution effect and a long-run complementary effect; 2) In both short-run and long-run, the Granger causality runs from the Sino-US and Japan-US trade imbalances to China's internal imbalances with different signs of effects. However, the Japanese internal imbalance is an extraneous to the model; 3) the US internal imbalance is the Granger cause of Sino-US trade imbalance with short-run positive and long-run negative effects, implying that the US internal imbalance indirectly lead to the China's internal imbalance. To some extent, we argue that exist power effect among above three countries.