The causality relationship between money supply, inflation and Real GDP

Seminar paper from the year 2016 in the subject Economics - Monetary theory and policy, , language: English, abstract: Since the main objective of the paper is to test the existence of causality relationship between the three macroeconomic variables, namely real GDP, price level (CPI) and M2 money supply (MS), analysis has been made there by employing 40 years of data. VAR Granger causality test has been made to verify the objective of the paper. The VAR Granger causality test result suggesting the existence of strong and significant correlation between the three variable s pairwise. The direction of causation is found to be a uni- directional causation between money supply and inflation, real GDP and Money supply and between real GDP and inflation and the causation runs from money supply to inflation, real GDP to Money supply and real GDP to inflation respectively. From the causation we observed that money supply has relationship with level of price and economic growth (real GDP). Basically targeting monetary expansion has a multiple role to boost economic growth and control the level of inflation. Keynesians, monetarists, and new classical economists agree that the steady state rate of inflation is closely related to growth of the money supply, and that monetary policy can not affect the equilibrium rate of unemployment. The best slogan of monetarist school of thought "money matters", they argued that changes in the amount of money in the circulation are the sources of other economic changes. In other words, the changes in the size of money supply have a number of implications on the macroeconomics variables especially inflation. Apart from being a powerful instrument of monetary policy, its expansion or contraction dictates the growth in investment and output of any economy. The supply of money is widely accepted as a key determinant of the levels of output and employment in the short run and the level of prices in the long run.