MONEY PRICE CAUSALITY AND THE ROLE OF FINANCIAL CRISIS

Abstract

Quantity Theory of Money is subject to many critiques. One major critique is that it does not provide causal relation between money and prices. It generates a direct and proportional relationship between money and prices. If we causally link money and prices, then it could be argued that monetary growth is not always inflationary. To test this argument, we have selected quarterly data of the U.S economy over the period of 1991 to 2011. We have divided the time series into -periods i.e., normal times {1991 to 2005} and crisis period {2006 to 2011}. Over these sub-samples, the study applied different econometric techniques like Ordinary Least Square (OLS), Autoregressive Distributive Lag Model (ARDL) and Johansen co-integration as per the requirements. In the normal time period, money growth and CPI inflation were not related, but it was directly related to HPI inflation. However, it was inversely related to both inflations in crisis times. Quantity theory relates money with the general price level of the economy. The joint price index of consumer goods and asset prices is the better proxy of a general price index. Finally, monetary growth is directly related to joint inflation in normal times and inversely related to crisis periods. Hence monetary growth is not always inflationary; it could be deflationary under some specific circumstances. Key Words: Quantity Theory of Money, Inflation, Time Series Data, Co-integration, Price Index.