Causality between Economic Policy Uncertainty across Countries : Evidence from Linear and Nonlinear Tests. Ahdi N. Ajmi 1.

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1 Causaly beween Economc Polcy Uncerany across Counres : Evdence rom Lnear and Nonlnear Tess Ahd N. Ajm 1 Rangan Gupa 2 Parck T. Kanda 3 Absrac Followng he global recesson economc polcy uncerany and s eec on economc recovery has become an ssue o neres n academc meda as well as polcy-makng crcles Baker e al Gven hs backdrop we nvesgae causaly beween economc polcy uncerany n some o he world's major economes usng he economc polcy uncerany ndex developed by Baker e al We mplemen boh he radonal lnear and he nonlnear varans o he Granger causaly es. Based on he Dks and Panchenko 2005 non-lnear Granger causaly es we nd sgncan evdence o bdreconal causaly beween counres' economc polcy uncerany across he sample. The resuls are conssen wh he ac ha he global economy has become more negraed hrough rade nancal and condence lnkages. Also our ndngs hghlgh ha nerence rom radonal lnear Granger causaly es can be msleadng n he presence o non-lneary n he daa. Keywords: economc polcy uncerany causaly lnear nonlnear JEL Classcaon: C14 C32 D80 E22 E66 F43 G18 L50 O40 1 College o Scence and Humanes n Slayel Salman bn Abdulazz Unversy Kngdom o Saud Araba emal: ahd.noomen@gmal.com 2 Correspondng auhor Deparmen o Economcs Unversy o Preora Preora 0002 Souh Arca phone: emal: Rangan.Gupa@up.ac.za 3 Deparmen o Economcs Unversy o Preora Preora 0002 Souh Arca emal: Parck.Kanda@up.ac.za 73

2 Ahd N. Ajm Rangan Gupa Parck T. Kanda - Causaly beween Economc Polcy Uncerany across Counres :Evdence rom Lnear and Nonlnear Tess - Froners n Fnance and Economcs Vol 11 N Inroducon The process o globalzaon has led o economes around he world o be nerconneced more han ever. Hence a shock relaed o any specc economc polcy change n one counry ges carred over across he world nsanly. Ths s more so he case when he economes where he shock orgnaes rom are he major role players n shapng world economc acvy. In oher words a specc counry s no only lkely o be aeced by shocks o s own economc polcy envronmen bu also due o economc polcy changes n oher major economes o he world and vce versa. Hence he nal eec o polcy uncerany on a parcular economy can no only be long lasng bu ncrease n magnude due o spllovers. Uncerany n economc polcy perceved by consumers and nvesors can have a negave mpac on economc recovery and growh. Consumers and nvesors are lkely o hesae n spendng and nvesng when hey sense hgher uncerany n he economc polcy envronmen. Economc uncerany also ends o aec he nancal marke negavely as valuaons o asses are lkely o drop. Hence economc uncerany no only counry-specc bu or oher economes as well s ollowed and analyzed closely by agens n he economy polcy makers and academc scholars around he world. Agans hs backdrop our paper analyzes he causal relaonshp beween economc polcy uncerany across major economes Canada Chna he aggregae Euro area France Germany Inda Ialy Span Uned Kngdom and Uned Saes n he world n a bvarae se-up usng boh lnear and nonlnear Granger causaly ess wh he counres chosen based on avalably o daa on he ndex measurng economc polcy uncerany developed recenly by Baker e al For he Uned Saes he polcyrelaed economc uncerany ndex s consruced based on quancaon o hree ypes o underlyng componens namely newspaper coverage o polcyrelaed economc uncerany he number o ederal ax code provsons se o expre n uure years and dsagreemen among economc orecasers. For Canada he ndvdual European counres and hence he aggregae Eoro area and Inda he ndex s based on newspaper coverage o polcy-relaed economc uncerany and dsagreemen among economc orecasers. Whle or Chna he ndex s consruced based on normaon o newspaper coverage o polcyrelaed economc uncerany only. The Appendx o he paper provdes a dealed dscusson o how he ndex s consruced or he varous counres. 74

3 Ahd N. Ajm Rangan Gupa Parck T. Kanda - Causaly beween Economc Polcy Uncerany across Counres :Evdence rom Lnear and Nonlnear Tess - Froners n Fnance and Economcs Vol 11 N Noe ha he decson o use nonlnear causaly ess over and above he sandard lnear Granger causaly es emanaes rom no only he possbly and as we show ha uncerany varable jus lke many nancal and macroeconomc varables s lkely o have nonlnear daa generang process bu also due o he ac ha he relaonshp beween uncerany across wo counres s lkely o and as we show encouner srucural breaks hus nvaldang he nerences drawn based on lnear ess. Speccally we look a causal relaonshps usng monhly daa on he economc polcy uncerany ndex over he perod o January 2001 o February Though daa or some o he counres are avalable beore he sarng dae o our analyss we choose January 2001 o ensure unormy o daa avalably across all counres chosen. To he bes o our knowledge hs s he rs sudy o analyze causal relaonshps usng lnear and non lnear se-ups n economc polcy uncerany beween major economes o he world. The only oher paper somewha relaed o our work ha we are aware o s by Colombo Whle analyzng he mpac o he economc polcy uncerany o he Unes Saes on macroeconomc varables o he Euro area he paper also shows ha an ncrease n economc polcy uncerany n he Uned Saes leads o a correspondng rse n he economc polcy uncerany o he Euro area as well. 4 The paper s srucured as ollows: Secon 2 presens he mehodology and Secon 3 dscusses he daa as well as he emprcal resuls. Secon 4 concludes he paper. 2 - Mehodology Ths secon dscusses n a chronologcal ashon he deren causaly ess used n hs paper wh he dscusson o he ess beng ordered 4 Sum 2012 analyzed he long-run relaonshp beween he economc polcy uncerany ndexes o he Uned Saes and he Euro Area and ound a posve and sascally sgncan conegrang relaonshp beween he wo varables o concern. Sum 2012 uses Augmened Dckey-Fuller 1979 un roo es ADF es o rs show ha he wo ndexes are nonsaonary and hen also use he same es o show ha he recovered errors rom he regresson beween hese wo ndexes are saonary hence mplyng conegraon. However we should be cauous abou hese resuls snce hey are based on he ADF es whch s known o have low power. Furher as we show below based on more powerul un roo ess we can rejec he null o un roo or boh he Uned Saes and he Euro area hus makng he conegraon analyss o Sum 2012 redundan. 75

4 Ahd N. Ajm Rangan Gupa Parck T. Kanda - Causaly beween Economc Polcy Uncerany across Counres :Evdence rom Lnear and Nonlnear Tess - Froners n Fnance and Economcs Vol 11 N n a way such ha he subsequen es bulds on he drawback o he preceedng one. We sar o wh he lnear Granger non-causaly es ollowed by he ess o nonlneary and srucural breaks and hen wo nonlnear causaly ess. The lnear Granger non-causaly es s naurally aracve because smply requres deermnng wheher he regresson model coecens assocaed o pas and curren values are sgncan. The lnear Granger non-causaly es assumes ha he daa generang process o he varables nvolved are lnear and also ha parameers o he regressons do no change over me. However he daa generang process o he varables are nonlnear due o regme swchng and hresholds and srucural breaks occur he basc assumpons o he Granger non-causaly ess are volaed and hence he nerences rom he lnear causaly es canno be reled upon. Hence aer conducng he lnear Granger non-causaly ess we es or nonlneary n he ndvdual uncerany seres usng he Brock e al es or deecng seral dependence n me seres and also examne sably o he parameers o he regresson model based on he ess developed by Andrews 1993 and Andrews and Ploberger Nonlneary and srucural breaks deeced mply ha no only do he varables evolve n a nonlnear ashon bu also he relaonshp beween he varables are nonlnear rasng doubs abou he resuls rom he Granger non-causaly ess. Hence we address hs drawback by makng use o wo nonparamerc Granger causaly ess namely Hemsra and Jones 1994 and Dks and Panchenko I mus be emphaszed here ha nonparamerc mehods are desrable snce hey emphasze predcon or causaly whou mposng any parcular unconal orm o he relaonshp beween he varables. Dks and Panchenko 2005 however pons ou ha he relaonshp esed by he wdely-used Hemsra and Jones 1994 es s generally no compable wh Granger causaly hus leadng o a bas owards rejecng he null hypohess o noncausaly. In lgh o hs we prmarly rely on he Dks and Panchenko 2005 varan o nonlnear Granger causaly es o make nal decsons on he causal relaonshps. 2.1 Lnear Granger Causaly Tes Accordng o Granger 1969 causaly beween wo saonary seres x and y can be dened usng he concep o predcably. x s sad o "Granger" cause y pas realzaons o compared o predcons usng hsorcal values o x mprove he predcon o x only. y 76

5 Ahd N. Ajm Rangan Gupa Parck T. Kanda - Causaly beween Economc Polcy Uncerany across Counres :Evdence rom Lnear and Nonlnear Tess - Froners n Fnance and Economcs Vol 11 N Assumng ha he saonary seres x and y are o lengh n a ormal es or Granger causaly beween x and y requres esmang a p -order lnear vecor auoregressve model VAR p o he orm: x 1 = y y x p 21 p 12 p 22 p y x p p where represens a whe nose process wh zero mean = 1 2 and covarance marx. p s he opmal lag order o he process seleced usng a sequenal lkelhood rao LR es. 1 and 2 are consans and s are parameers. Gven hs ramework x and y represen he economc polcy uncerany ndces or counry and counry j respecvely hen we can es he null hypohess ha counry 's economc polcy uncerany does no Granger cause counry j 's economc polcy uncerany by mposng zero resrcons.e. = 0 or k = 12 p. Imposng such resrcons means 12k ha counry 's economc polcy uncerany does no conan any predcve conen or counry j 's economc polcy uncerany he jon zero resrcons under H E H 0 s no rejeced. E 0 : p = = = = 0 2 In a smlar ashon o es he null hypohess ha counry j 's economc polcy uncerany does no Granger causes counry 's polcal uncerany mples ha zero resrcons = 0 or k = 12 p mus be mposed. Ths means ha counry j 's economc polcy uncerany does no conan any predcve conen or counry 's economc polcy uncerany E he jon zero resrcons under H 0 s no rejeced. H E 0 : p 21k = = = =

6 Ahd N. Ajm Rangan Gupa Parck T. Kanda - Causaly beween Economc Polcy Uncerany across Counres :Evdence rom Lnear and Nonlnear Tess - Froners n Fnance and Economcs Vol 11 N Nonlneary and Parameer Sably Tes To check wheher here s a msspeccaon or no n he Granger noncausaly es he daa generang process or he varables s nonlnear we look a he Brock e al es o deecng nonlneary. The es popularly known as he BDS es s a powerul ool or deecng seral dependence n me seres. I ess he null hypohess o ndependen and dencally dsrbued..d agans an unspeced alernave. The BDS es can deec nonlneary provded ha any lnear dependence or nsance due o nonsaonary has been removed rom he daa. Furher he lnear Granger non-causaly es assumes ha he VAR's parameers do no change over me. However he presence o srucural breaks volaes hs assumpon. Also Granger 1996 argues ha parameer nonconsancy s a key challenge n curren emprcal sudes. Gven hs backdrop we es or sably o he VAR's parameers. Praccally varous ess can be conduced o sudy he emporal sably o a VAR model e.g. Hansen 1992; Andrews 1993; Andrews and Ploberg Followng Andrews 1993 and Andrews and Ploberger 1994 we nvesgae he sably o shor-run parameers by usng he Sup-F Ave-F and Exp-F ess. The Sup-F sasc s approprae when esng wheher a oneme sw regme sh n parameers occurred. The Ave-F and Exp-F 5 assume ha parameers ollow a marngale process and es wheher parameers have evolved gradually over me. These ess are obaned rom he sequence o LR sascs ha es he null hypohess o consan parameers agans he alernave o a one-me srucural change a each possble pon o me n he enre sample. Crcal values or he non-sandard asympoc dsrbuons o hese ess are repored n Andrews 1993 and Andrews and Ploberger However nsead o usng asympoc dsrbuons crcal values and p-values are compued usng a paramerc boosrap mehod. To hs end p-values are compued rom a boosrap approxmaon o he null dsrbuon o he es sascs consruced usng Mone Carlo smulaons based on 2000 samples generaed rom a VAR model wh consan parameers. Based on Andrews 1993 we rm 15 percen 5 Andrews and Ploberger 1994 prove ha he Ave-F and Exp-F are opmal ess. 78

7 Ahd N. Ajm Rangan Gupa Parck T. Kanda - Causaly beween Economc Polcy Uncerany across Counres :Evdence rom Lnear and Nonlnear Tess - Froners n Fnance and Economcs Vol 11 N rom boh ends o he sample and compue he Sup-F Ave-F and Exp-F ess or he remanng racon [ ] o he sample. 2.3 Nonlnear Granger Causaly Tes Alhough he lnear Granger causaly esng s desrable owng o s ease o mplemenaon has some drawbacks. Gven ha s a paramerc es he lnear Granger causaly es requres ceran modelng assumpons o whch he mos mporan s he lneary o he regresson srucure. Noneheless mos economc and nancal seres have been shown o exhb nonlneares emanang n ceran cases rom srucural breaks or he daa generang process beng nonlnear. In addon Baek and Brock 1992 nd ha he lnear Granger causaly es may al o deec nonlnear eecs on he condonal dsrbuon gven ha s only sensve o causaly n he condonal mean. Dks and Pachenko also argue ha a hgher order srucure such as condonal heeroskedascy can oen be gnored. In he same perspecve radonal lnear Granger causaly ess have been ound o have low power or deecng some nonlnear relaonshps Hemsra and Jones Gven hs backdrop nonparamerc mehods are desrable snce hey emphasze predcon whou mposng any parcular unconal orm. One o he mos promnen nonparamerc ess n he leraure s a varan o Baek and Brock 1992 developed by Hemsra and Jones On he oher hand Dks and Panchenko 2005 develop an alernave nonlnear es on he bass ha he relaonshp esed by Hemsra and Jones 1994 s generally no compable wh Granger causaly leadng o a bas owards rejecng he null hypohess o noncausaly. Thereore hs sudy prmarly reles on he Dks and Panchenko 2005 varan o nonlnear Granger causaly ess The Hemsra-Jones Tes Hemsra and Jones 1994 develop a nonparamerc sascal procedure o deec nonlnear causal relaonshps usng he correlaon negral. To dene he concep o nonlnear Granger causaly le } and } 79 { =123 T be wo srcly and weakly dependen me seres. Le represen he m -lengh lead vecor o and le desgnae he Lx -lengh and Ly -lengh vecors o and Lx Lx and { m Ly Ly respecvely.

8 Ahd N. Ajm Rangan Gupa Parck T. Kanda - Causaly beween Economc Polcy Uncerany across Counres :Evdence rom Lnear and Nonlnear Tess - Froners n Fnance and Economcs Vol 11 N Gven he values o m Lx and Ly 1 and > 0 } does no Granger cause { } : 6 m m Lx Lx Ly Ly P < < < s Lx slx Ly { sly m m Lx Lx = P < < 4 s Lx slx where P. denoes probably and. represens he maxmum m m norm. Accordng o Eq. 4 he probably ha and s arbrary m - lengh lead vecors o { } are whn a dsance rom each oher condoned on he ac ha he correspondng Lx -lengh lag vecors o { }.e. Lx Lx and nroduces he condon ha { } are also -close. Lx slx are also separaed by s equal o he case when one Ly Ly and Ly sly wo Ly -lengh lag vecors o To es Eq. 4 condonal probables are expressed n erms o he correspondng raos o jon probables as ollows: C1 m Lx Ly C3 m Lx = C2 Lx Ly C4 Lx 5 where C 1 C 2 C 3 and C 4 represen he correlaon negral esmaor o he jon probables Hemsra and Jones Usng an addonal ndex n and assumng } and } are srcly saonary { weakly dependen Hemsra and Jones 1994 demonsrae ha { } does no srcly Granger cause { } hen { C1 m Lx Ly n C3 m Lx n 2 n ~ AN0 m Lx Ly C2 Lx Ly n C4 Lx n 6 6 Accordng o Hemsra and Jones 1994 src Granger causaly mples ha hsorcal values o one me seres nluence he curren and uure values o anoher me seres. 80

9 Ahd N. Ajm Rangan Gupa Parck T. Kanda - Causaly beween Economc Polcy Uncerany across Counres :Evdence rom Lnear and Nonlnear Tess - Froners n Fnance and Economcs Vol 11 N where n = T 1 m max Lx Ly. The appendx o Hemsra and Jones 1994 presens he denon and an esmaor o 2 m Lx Ly. Gven hs asympoc resul rgh-aled crcal values are used rejecng he null hypohess when he compued value o he es sasc n Eq. 6 s oo large. Tesng or nonlnear Granger causaly beween { } and { } requres applyng he es n Eq. 6 o he esmaed resdual seres rom he bvarae VAR model. The null hypohess s " } does no nonlnearly srcly Granger cause { } " and Eq. 6 holds m Lx Ly 1 and > 0. By removng a lnear predcve power rom a lnear VAR model any remanng ncremenal predcve power o one resdual seres or anoher can be consdered as nonlnear predcve power Baek and Brock The Dks-Panchenko Tes Respondng o he shorcomng o he Hemsra and Jones 1994 es Dks and Panchenko 2005 propose a es ha reduces he rsk o bas n rejecng he null hypohess o non-causaly. As a soluon Dks and Panchenko 2006 develop a Granger non-causaly paramerc es ha uses an average o local condonal dependence measures raher han he global sasc. l Assumng ha = l 1 and = l 1 represen he delay vecors and l 1. The null hypohess ha l conan any addonal normaon abou l { s dened as ollows: l l l l 0 = 1 ; 1 l H : 7 The null hypohess s a saemen abou he nvaran dsrbuon o he l l 1 -dmensonal vecor W = Z where Z = 1. Ignorng he me ndex and assumng ha l l = 1 he dsrbuon o Z 81 l = l

10 Ahd N. Ajm Rangan Gupa Parck T. Kanda - Causaly beween Economc Polcy Uncerany across Counres :Evdence rom Lnear and Nonlnear Tess - Froners n Fnance and Economcs Vol 11 N gven ha = y x - s dencal o ha o Z gven y =. Tha s o say and Z are ndependenly condonally on y = or each xed value o y so he jon probably densy uncon z y x Z and s margnals mus sasy he ollowng relaonshp:. = y z y y y x y z y x Z Z 8 Accordng o Dks and Panchenko 2006 he resaed null hypohess mples ha: = 0 ] [ Z Z E q Z Z 9 where ˆ W W represens a local densy esmaor o a W d -varae random vecor W a W dened by W j j j W d n W I n W 1 1 = 2 ˆ where < = n j W j W W I I. I s he ndcaor uncon and n s he bandwdh and depends on n he sample sze. The es sasc s dened as: ˆ ˆ ˆ ˆ. 2 1 = Z Z n n Z Z n n n T 10 where n T consss o a weghed average o local conrbuons ˆ ˆ ˆ ˆ Z Z Z Z whch approach zero n probably under 0 H. Dks and Pachenko 2006 show ha 3 1 < < 4 1 > 0 = c Cn n or one lag hen he es sasc n Eq. 4 sases:

11 Ahd N. Ajm Rangan Gupa Parck T. Kanda - Causaly beween Economc Polcy Uncerany across Counres :Evdence rom Lnear and Nonlnear Tess - Froners n Fnance and Economcs Vol 11 N Tn n q n D N01 S n 11 where D denoes convergence n dsrbuon and S n represens an esmaor o he asympoc varance o T n Daa and Emprcal Resuls 3.1 Daa and Prelmnary Analyss Baker e al develop an economc polcy uncerany EPU ndex o measure polcy-relaed economc uncerany n he world's major economes. The ndex s based manly on wo underlyng componens: newspaper coverage o polcy-relaed economc uncerany and economc orecasers' dsagreemens abou nlaon and governmen purchases. Furher deals on he consrucon o he ndex or he varous counres s avalable n he Appendx o he paper. We use monhly daa spannng rom January 2003 o February 2013 or he EPU ndex o Canada Chna he Euro area France Germany Inda Ialy Span he UK and he US. The daa seres are obanable on-lne rom: Fgure 1 plos he naural logarhm o he EPU ndex or counres under nvesgaon across he sample perod. 83

12 Ahd N. Ajm Rangan Gupa Parck T. Kanda - Causaly beween Economc Polcy Uncerany across Counres :Evdence rom Lnear and Nonlnear Tess - Froners n Fnance and Economcs Vol 11 N Fgure 1: Naural logarhm o economc polcy uncerany EPU ndex Baker e al Canada Chna Euro area France Germany 5.6 Inda 5.6 Ialy 5.6 Span Uned Kngdom 5.6 Uned Saes Beore esng or nonlneary n he uncerany seres sably o he VARp model's parameers as well as he parwse Granger causaly we nvesgae he order o negraon o each counry's EPU ndex by means o he Augmened Dckey-Fuller ADF 1979 es Phllps 1987 and Phllps- Perron 1988's Z un roo es and Ng-Perron 2001's MZ es. Checkng or saonary o he daa s mporan snce all our ess nonlneary srucural breaks lnear and nonlnear causaly requre ha 84

13 Ahd N. Ajm Rangan Gupa Parck T. Kanda - Causaly beween Economc Polcy Uncerany across Counres :Evdence rom Lnear and Nonlnear Tess - Froners n Fnance and Economcs Vol 11 N varables mus be saonary. Based on he MZ es - whch has hgher power compared o he ADF and Z un roo ess - we can conclude ha all he EPU ndex seres are saonary Resuls rom he Lnear Granger Causaly Tes Aer esmang a VARp model 8 9 we perorm he lnear Granger causaly es wh he null hypohess o absence o causaly runnng rom counry 's economc polcy uncerany o counry j 's. Table 1 presens he resuls. There s evdence o causaly runnng rom counry 's economc polcy uncerany o counry j 's n 51 cases ou o 85. O hese 30 cases 10 comprse counry pars ha exhb bdreconal causaly o economc polcy uncerany. The remanng 21 cases 11 exhb undreconal causaly beween counres' economc polcy uncerany. For he remanng 34 cases 12 he es als o esablsh a causal relaonshp runnng rom counry 's economc polcy uncerany o counry j 's. 7 For brevy purposes we do no repor hese ess n he paper. However hey are avalable rom he auhors upon reques. 8 Usng he Akake Inormaon Creron AIC Table A.1 n he Appendx repors he lag lenghs used n he speccaon o he VARp model specc o each counry par. 9 We have excluded he ordered pars Euro Area-France Euro Area-Germany Euro Area-Ialy Euro Area-Span and Euro Area-UK gven ha he EU's EPU ndex s consruced based on underlyng normaon gahered rom s members. Agans hs backdrop he number o possble cases pars or our sample o 10 counres s gven by: n! 10! 5 = 5 = 85 n r! 10 2! 10 The ollowng ordered pars as well as her respecve nverses: Canada-Chna Canada-Euro area Canada-Germany Canada-UK Canada-US Euro area-inda Span-France France-UK Germany-Inda Germany-Ialy Germany-UK Inda-Ialy Inda-UK Span-UK and UK-US. 11 The ordered pars are: Canada-France Canada-Ialy Canada-Span Euro area-chna Germany-Chna Germany-Euro area Germany-France Inda-Canada Inda-Chna Inda-Span Ialy-Chna Span-Euro UK-Chna UK-Ialy US-Chna US-Euro area US-France US- Germany US-Inda US-Ialy and US-Span 12 The ordered pars are as ollows: Canada-Inda Chna-Euro area Chna-France Chna- Germany Chna-Inda Chna-Ialy Chna-Span Chna-UK Chna-US Euro area-us France- Canada France-Chna France-Euro area France-Germany France-Inda France-Ialy France- US Germany-Span Germany-US Inda-France Inda-US Ialy-Canada Ialy-Euro area Ialy- France Ialy-Span Ialy-UK Ialy-US Span-Canada Span-Chna Span-Germany Span- Inda Span-Ialy Span-US and UK-Euro area. 85

14 Counry j Counry Ahd N. Ajm Rangan Gupa Parck T. Kanda - Causaly beween Economc Polcy Uncerany across Counres :Evdence rom Lnear and Nonlnear Tess - Froners n Fnance and Economcs Vol 11 N Table 1: Resuls rom lnear Granger causaly es Canada Chna Euro Area France Germany Inda Ialy Span UK US Canada a c c a b a b b Chna b Euro Area a c a France a b Germany a c c c a b c Inda a a a a a b b Ialy b c b Span b a c UK a a a a b b b a US a c a c a b b b a - Noes: Ths able repors he p-values o he Granger causaly ess. a b and c ndcae he rejecon o he null hypohess o absence o causaly runnng rom counry o counry j a he 1% 5% and 10% levels respecvely. In he cases where he lnear es conrms evdence o bdreconal causaly he causal relaonshp predomnanly nvolves advanced economes such as Canada France Span Ialy he UK and he US. Such oucomes are nuve gven he nerconnecedness o hese economes. However some resuls rase suspcon. For nsance conrary o observaon made durng he Eurozone deb crss resuls rom he lnear Granger causaly es end o sugges ha here s no causal relaonshp beween economc polcy uncerany nvolvng a number o Eurozone counres. To llusrae whle here s evdence o causaly beween Ialy's and Germany's economc polcy uncerany he lnear es nds no evdence o causaly beween Ialy's economc polcy uncerany on he one hand and ha n France Span he UK as well as he Euro area as a whole on he oher hand. Recen experence has shown ha concerns over scal polcy paralyss and soveregn deb n counres such as Ialy and Span as well as counres on he perphery such as Greece and Cyprus have had consderable ramcaons hroughou he whole zone. Thereore we queson he ac ha lnear ess esablsh causaly n some cases bu al o do so n oher smlar and relaed nsances. 86

15 Ahd N. Ajm Rangan Gupa Parck T. Kanda - Causaly beween Economc Polcy Uncerany across Counres :Evdence rom Lnear and Nonlnear Tess - Froners n Fnance and Economcs Vol 11 N Resuls rom Nonlneary and Parameer Sably Tess Frs resuls rom he BDS es repored n Table 2 ndcaes ha he null hypohess ha he seres are..d. s rejeced or all counres. Consequenly he resuls rom he es sugges ha here may be nonlnear srucure n he daa. Second ollowng Andrews 1993 and Andrews and Ploberger 1994 we perorm he Sup-F Ave-F and Exp-F ess o nvesgae he parameer sably o he VARp model. All ess.e Sup-F Ave-F and Exp-F mus al o rejec he null hypohess or us o conclude ha he VARp's parameers are sable. Table 3 presens he conclusons o he parameer sably ess where he null hypohess s ha o parameer sably. We deny 25 cases where all ess show evdence o parameer sably a he 10% level o sgncance. However a leas one o he hree ess rejecs he null hypohess o parameer sably or he majory o ordered counry pars -.e. he remanng 60 cases. Table 2: BDS es resuls Dm Canada Chna Euro Area France Germany Inda Ialy Span UK US Noes: Dm sands or dmenson. Table repors he p-values o he BDS es. Counry j Counry Table 3: Parameer sably ess Canada Chna Euro Area France Germany Inda Ialy Span UK US Canada - n3 n3 n3 n3 y3 n2 n3 n1 n3 Chna n1 - n3 n3 n3 n3 n3 n3 n1 n3 Euro Area n3 n n y3 France n1 n3 n1 - n3 n1 n1 n1 n1 n1 Germany n3 n3 n1 n1 - n3 n3 n2 n3 y3 Inda y3 n2 y3 y3 y3 - n2 y3 y3 y3 Ialy y3 y3 y3 y3 n1 n1 - y3 y3 n1 Span n3 y3 n2 y3 n1 y3 n2 - y3 y3 UK n3 n3 n2 n1 n2 y3 n3 n3 - y3 US n3 n2 y3 n2 n3 n3 y3 n1 n1 - Noes:H 0 : parameer sably; "y" sands or "yes" and means al o rejec H 0 a 10% level o sgncance; numbers n beween reer o number o ess alng o rejec H 0. "n".e. "no" means rejec H 0 a 0.1 level o sgncance. Counry j n row column header. 87

16 Ahd N. Ajm Rangan Gupa Parck T. Kanda - Causaly beween Economc Polcy Uncerany across Counres :Evdence rom Lnear and Nonlnear Tess - Froners n Fnance and Economcs Vol 11 N Resuls rom he Dks-Panchenko Nonlnear Granger Causaly Tes Because he lnear Granger causaly es s sensve o nonlneary n he daa generang process and srucural breaks n he relaonshp beween he uncerany varables across wo specc pars o economes nerences based on such a es are msleadng especally gven he evdence o nonlneary n all he 10 counres and parameer non-consancy n 60 ou o 85 cases dened. Thereore we perorm parwse nonlnear Granger causaly ess ollowng Dks and Panchenko Table 4 repors he resuls. We rejec he null hypohess o he absence o causaly runnng rom counry 's economc polcy uncerany o counry j 's n 83 cases. The resuls also suppor bdreconal causaly n all hese cases. Barrng he cases nvolvng he ordered pars o Ialy-Euro area and Span-Ialy we have causaly runnng n boh drecons n all oher remanng cases. These resuls could be explaned by he ncrease n lnkages among he major global economes due o globalzaon. In ac economc and nancal condons n he world's larges economes are nerlnked. The recen nancal crss and he ensung global recesson have exposed he ac ha here are close rade nancal as well as condence lnkages among he world's major economes. As such an ncrease n economc polcy uncerany n a gven counry and he resulng mbalances n rade nancal and condence rends would have spllover eecs ono oher counres' economc polcy uncerany. Overall our resuls hghlgh ha no accounng or nonlneary n he daa generang process o a seres as well as nonlneary n he relaonshp beween wo seres would lead o ncomplee and msleadng resuls derved rom relyng smply on lnear ess. Gven hs echncal glch hen leads o napproprae polcy decsons and economc oucomes. Table 4: Dcks-Panchenko nonlnear causaly es Counry j Counry Lags Chna Euro Area France Germany Inda Ialy Span UK US Canada b a a a a b b b b b c c c b c b c c c c c c c 13 Resuls rom he Hemsra and Jones 1994 es are repored n he Appendx. 88

17 Ahd N. Ajm Rangan Gupa Parck T. Kanda - Causaly beween Economc Polcy Uncerany across Counres :Evdence rom Lnear and Nonlnear Tess - Froners n Fnance and Economcs Vol 11 N c c c Counry j Counry lag Canada Euro Area France Germany Inda Ialy Span UK US Chna b b c b a a b c b b b b c b b b b b c c c b c c b b c c c c b b c b c b c b c b c b b b c c c b c c c Counry j Counry lag Canada Chna France Germany Inda Ialy Span UK US Euro Area a b a a a a a a c b a c b a b b b Counry j Counry Lags Canada Chna Euro Area Germany Inda Ialy Span UK US France b c b b b b a a a b b b a b b b b a b b b c b b b a b b b c b b a c b b c c b b b b b b b c b b b b c b b c b b c b c b c c 89

18 Ahd N. Ajm Rangan Gupa Parck T. Kanda - Causaly beween Economc Polcy Uncerany across Counres :Evdence rom Lnear and Nonlnear Tess - Froners n Fnance and Economcs Vol 11 N Counry j Counry lag Canada Chna Euro Area France Inda Ialy Span UK US a b c b a c b b b a b b b c c a c Germany b c b c b b b b b c c c Noes: Ths able repors he p-values o he Dcks-Panchenko causaly ess. a b and c ndcae he rejecon o he null hypohess o absence o causaly runnng rom counry o counry j a he 1% 5% and 10% levels respecvely. Counry Inda Table 4 connued: Dcks-Panchenko nonlnear causaly es Counry j lag Canada Chna Euro Area France Germany Ialy Span UK US a a b b b a b b a b b b a b b b a b b c c a b c b b b b c b a c c c b b b b b c c b b c c b b b b c c c b c b Counry Ialy b c c c c c c Counry j Lags Canada Chna Euro Area France Germany Inda Span UK US b c b b a c c c b c c c b b c c

19 Ahd N. Ajm Rangan Gupa Parck T. Kanda - Causaly beween Economc Polcy Uncerany across Counres :Evdence rom Lnear and Nonlnear Tess - Froners n Fnance and Economcs Vol 11 N Counry c Counry j lag Canada Chna Euro Area France Germany Inda Ialy UK US b c b b b a b b c b b a b b b b Span b b b b b c b b c b b c Counry UK b c c Counry j lag Canada Chna Euro Area France Germany Inda Ialy Span US a b a a a a a b a a b b b a a c a a b b a b b c b a b c b b b c b b b b c c c a b b a c b b Counry US b c c c c Counry j Lags Canada Chna Euro Area France Germany Inda Ialy Span UK a a a a a a a a a a b a a b a a b b a b b b b b b c a b b b c b b b b b b b b b b b b c b c b b b c b c b 91

20 Ahd N. Ajm Rangan Gupa Parck T. Kanda - Causaly beween Economc Polcy Uncerany across Counres :Evdence rom Lnear and Nonlnear Tess - Froners n Fnance and Economcs Vol 11 N b b c c b c Noes: Ths able repors he p-values o he Dcks-Panchenko causaly ess. a b and c ndcae he rejecon o he null hypohess o absence o causaly runnng rom counry o counry j a he 1% 5% and 10% levels respecvely. 4 - Concluson Accordng o he IMF 2012 uncerany s counercyclcal. I ends o rse durng he downward phase o he busness cycle and all durng an upward phase. Ths asseron s n lne wh Baker e al.2012's ndngs ha economc polcy uncerany has ncreased n he wake o he recen global recesson. Gven ha globalzaon has creaed exensve rade and nancal lnkages across he world we nvesgae wheher a causal relaonshp exss beween economc polcy uncerany or pars o major global economes. Due o shorcomngs o he lnear Granger causaly es especally n he presence o nonlneary and srucural breaks exsence o whch has been ndcaed above our sudy reles on he nonlnear varan o he Granger causaly es as developed by Dks and Panchenko We nd exensve and sgncan evdence o cross-counry economc polcy uncerany causal relaonshps. Counry j Counry Table 5: Summary o resuls rom he lnear and nonlnear Granger causaly ess Canada Chna Euro Area France Germany Inda Ialy Span UK US Canada - l nl l nl l nl l nl nl l nl l nl l nl l nl Chna l nl - nl nl nl nl nl nl nl nl Euro Area l nl l nl l nl nl France nl nl nl - nl nl nl l nl l nl nl Germany l nl l nl l nl l nl - l nl nl nl l nl nl Inda l nl l nl l nl nl l nl - l nl l nl l nl nl Ialy nl l nl - nl l nl l nl - nl nl nl Span nl nl l nl l nl nl nl - - l nl nl UK l nl l nl nl l nl l nl l nl l nl l nl - l nl US l nl l nl l nl l nl l nl l nl l nl l nl l nl - Noe: "l" "nl" means ha he lnear nonlnear Granger causaly es shows evdence o causaly runnng rom counry 's economc polcy uncerany o counry j's based on a leas any o he convenonal levels o sgncance. As shown n Table 5 he Dks-Panchenko 2005 es ouperorms he 92

21 Ahd N. Ajm Rangan Gupa Parck T. Kanda - Causaly beween Economc Polcy Uncerany across Counres :Evdence rom Lnear and Nonlnear Tess - Froners n Fnance and Economcs Vol 11 N radonal Granger causaly es n unvelng causal relaonshps. The Dks- Panchenko 2005 es maches all nsances where he lnear es esablshes causaly. In addon he non-lnear es uncovers causaly n cases where he lnear es aled. Overall our resuls have wo mporan mplcaons: Frs rom a echncal pon o vew one needs o explcly es or nonlneary o ndvdual seres and srucural breaks n he relaonshp whle analyzng causal relaonshps. Snce alure o accoun or nonlneary and srucural changes and relance on only lnear Granger causaly ess would al o pck up all possble causal relaonshps and lead o ncomplee and msleadng conclusons and; second rom a polcy perspecve s mporan or he polcy-makers o a specc counry o realze ha he economc envronmen o her counry s lkely o be aeced by polcy decsons n anoher counry counres as well over and above her own polcy decsons. Smlarly n a globalzed world he ormulaon o hs parcular counry's domesc economc polces are smulaneously gong o have poenal repercussons on oher counres' economes hrough rade and nancal lnkages mplyng ha a one-me polcy change n a specc counry or anoher counry s lkely o have more perssen eec over me. Reerences Andrews D. W. K Tess or parameer nsably and srucural change wh unknown change pon. Economerca Andrews D. W. K. and W. Ploberger Opmal ess when a nusance parameer s presen only under he alernave. Economerca Baek E. and W. Brock A general es or non-lnear Granger causaly: bvarae model. Workng paper. Iowa Sae Unversy and Unversy o Wsconsn Madson WI. Brock W. D. Decher J. Schenkman and B. LeBaron A es or ndependence based on he correlaon dmenson. Economerc Revews Baker S. N. Bloom and S. Davs Measurng economc polcy uncerany. Chcago Booh Research Paper Colombo V Economc Polcy Uncerany n he US: Does maer or he Euro Area? Economcs Leers Dckey D. A. and A. Fuller Dsrbuon o he esmaors or auoregressve me seres wh a un roo. Journal o he Amercan 93

22 Ahd N. Ajm Rangan Gupa Parck T. Kanda - Causaly beween Economc Polcy Uncerany across Counres :Evdence rom Lnear and Nonlnear Tess - Froners n Fnance and Economcs Vol 11 N Sascal Assocaon Dks C. G. H. and V. Panchenko A noe on he Hemsra-Jones es or Granger noncausaly. Sudes n Nonlnear Dynamcs and Economercs Dks C. G. H. and V. Panchenko A new sasc and praccal gudelnes or nonparamerc Granger causaly esng. Journal o Economc Dynamcs and Conrol Granger C. W. J Invesgang causal relaons by economerc models and cross-specral mehods. Economerca Granger C. W. J Can we mprove he perceved qualy o economc orecass? Journal o Appled Economercs Hemsra C. and J. D. Jones Tesng or lnear and nonlnear Granger causaly n he sock prce-volume relaon. Journal o Fnance IMF Copng wh hgh deb and sluggsh growh. World Economc Oulook Washngon DC. Ng S. and P. Perron Lag lengh selecon and he consrucon o un roo ess wh good sze and power. Economerca Phllps P. C. and P. Perron Tesng or a un roo n me seres regresson. Bomerka Sum V Economc polcy uncerany n he Uned Saes and Europe: a conegraon es. Inernaonal Journal o Economcs and Fnance

23 Ahd N. Ajm Rangan Gupa Parck T. Kanda - Causaly beween Economc Polcy Uncerany across Counres :Evdence rom Lnear and Nonlnear Tess - Froners n Fnance and Economcs Vol 11 N Appendx Counry The VARp lag lenghs Counry j Table A.1: Opmal lag lengh ess o he VAR Canada Chna Euro Area France Germany Inda Ialy Span UK US Canada - Chna 4 - Euro Area France Germany Inda Ialy Span UK US Noe: Ths able repors he VARp's lag lengh based on he Akake Inormaon Creron AIC. Counry Canada Counry The Hemsra-Jones ess resuls Table A.2: Hemsra-Jones nonlnear causaly es Counry j Lags Chna Euro Area France Germany Inda Ialy Span UK US a a a a a b a a a a b a a a a c a Counry j lag Canada Euro Area France Germany Inda Ialy Span UK US Chna

24 Counry Euro Area Counry France Counry Germany Ahd N. Ajm Rangan Gupa Parck T. Kanda - Causaly beween Economc Polcy Uncerany across Counres :Evdence rom Lnear and Nonlnear Tess - Froners n Fnance and Economcs Vol 11 N a b a a a a a a a a Counry j lag Canada Chna France Germany Inda Ialy Span UK US a a a a a a a Counry j Lags Canada Chna Euro Area Germany Inda Ialy Span UK US a a a a b a a a a a Counry j lag Canada Chna Euro Area France Inda Ialy Span UK US a a a a a a b a

25 Ahd N. Ajm Rangan Gupa Parck T. Kanda - Causaly beween Economc Polcy Uncerany across Counres :Evdence rom Lnear and Nonlnear Tess - Froners n Fnance and Economcs Vol 11 N a a b a b a Noes: Ths able repors he sandardzed es sasc o Hemera-Jones "lags" denoes he number o lags n he resdual seres used n he es. a b and c ndcae he rejecon o he null hypohess o absence o causaly runnng rom counry o counry j a he 1% 5% and 10% levels respecvely. Counry Inda Counry Ialy Counry Table A.2 connued: Hemsra-Jones nonlnear causaly es Counry j lag Canada Chna Euro Area France Germany Ialy Span UK US a a a a a a a a a c a a Counry j Lags Canada Chna Euro Area France Germany Inda Span UK US a a a b a a b a a b a a a b b a Counry j lag Canada Chna Euro Area France Germany Inda Ialy UK US 97

26 Span Counry UK Counry Ahd N. Ajm Rangan Gupa Parck T. Kanda - Causaly beween Economc Polcy Uncerany across Counres :Evdence rom Lnear and Nonlnear Tess - Froners n Fnance and Economcs Vol 11 N a a a b a a a a a a a a b a a a a Counry j lag Canada Chna Euro Area France Germany Inda Ialy Span US a a a a a a a a a a a c a a a a a a a a Counry j Lags Canada Chna Euro Area France Germany Inda Ialy Span UK a US a b a a a b a a a Noes: Ths able repors he sandardzed es sasc o Hemera-Jones 1994."lags" denoes he number o lags n he resdual seres used n he es. a b and c ndcae he rejecon o he null hypohess o absence o causaly runnng rom counry o counry j a he 1% 5% and 10% levels respecvely. 98