Causality and correlations of output and nominal variables in a real business cycle model

Abstract

A dynamic general equilibrium economy in which output is exogenous with respect to money is calibrated and simulated following a procedure commonly used in the real business cycle literature. It is then confronted with key comovement patterns of output and nominal variables in post-war U.S. time series data. The model economy performs well in matching second-moment patterns involving output, money, and price. The model economy — with its embedded ‘reverse causation’ from output to money — also provides the means for carrying out a probabilistic appraisal of the observed money to output Granger causality in U.S. data. Repeated applications of the Granger causality test to simulated data lead to the rinding that money causes output more often than expected.