Controlling Money Supply And Price Level With Unknown Regime Shifts: The Case Of Chile

Abstract

<p class="MsoNormal" style="text-align: justify; margin: 0in 0.5in 0pt;"><span style="font-size: 10pt;" lang="EN-GB"><span style="font-family: Times New Roman;">This paper investigates the relationship between money supply and price level using new tests for cointegration with two unknown regime shifts and bootstrap causality tests. Quarterly Chilean data from 1973: I to 2006: III is used. We find empirical evidence that the variables establish a long-run steady state relationship in the presence of two regime shifts. The elasticity of price level with regard to money supply is close to unity during the first period (prior to 1978: II). The elasticity is reduced during the second period (1978: III-1986: I) and it is also reduced for the remaining period but the reduction is smaller. We also conducted bootstrap causality tests that reveal the following: in the first sub-period there is bidirectional causality between the underlying variables. In the last two sub-periods money supply causes the price level only. This implies that money supply is weakly exogenous concerning the price level and that the monetary authority had enough independence to execute an active monetary policy in Chile. <span style="mso-bidi-font-weight: bold;"></span></span></span></p>