Granger Causality Between Money and Income for the Japanese Economy in the Presence of a Structural Change

Abstract

This paper examines Granger causality between money and income in the Japanese economy based upon a bivariate VAR model with a structural change in the trend function. We employ a stratified testing strategy incorporating preliminary tests for a unit root and for the order of cointegration rank. Our study reveals that the choice of either trend stationarity or difference stationarity, as well as the order of cointegration rank, crucially affect the test results for Granger causality. It is found that the causality from money to income was strong before 1980 but weakened or virtually disappeared after 1980; the opposite causality existed weakly before 1980 but not after 1980. The result confirms the claim by the Bank of Japan (1992) and Honda et al. (1995) among others that the role of money as a leading indicator for predicting movements in income has weakened or even disappeared in the 1980s. JEL Classification Numbers: C32, E40