An approach to testing the exogeneity of the money supply in Brazil by mixing Kalman filter and cointegration procedures: 1964.02 to 1986.02

Abstract

We examine the extent of the exogeneity of the money supply using monthly data spanning from 1964.04 to 1986.02. The tests applied investigated the plausibility of classical hypotheses. We employed Kalman Filter procedures, Johansen cointegration procedures, and the bootstrap approach. We argued that the real rate of interest did cause, in the Granger sense, the bond stock supporting the claim that the monetary authority was able to perform indirect monetary control through open market transactions. The results show that seigniorage collection was a white noise and econometrically independent from the inflation rate. Money creation and the inflation rate were cointegrated. We found that money growth was weakly exogenous for the parameter of interest in the conditional model of inflation, but the reverse is not true for inflation. Moreover, Granger’s causal relation between them was unidirectional from money to inflation. Therefore, money growth was strongly exogenous concerning the inflation rate. These empirical findings differ greatly from many previous results. Our main contribution is having demonstrated that the monetary supply was exogenous with respect to the inflation rate and that the monetary authority had enough independence to execute an active monetary policy.

Key words: Kalman filtering, cointegration procedures, bootstrap, econometric modeling, inflation, money supply, monetary policy.