Testing for nonlinear causation between capital inflows and domestic prices

Transcription

1 MPRA Munich Personal RePEc Archive Tesing for nonlinear causaion beween capial inflows and domesic prices Abdul Rashid Inernaional Insiue of Islamic Economics (IIIE) Inernaional Islamic Universiy (IIU), Islamabad, Pakisan 4. June 00 Online a hps://mpra.ub.uni-muenchen.de/608/ MPRA Paper No. 608, posed 3. Ocober 00 00:7 UTC

2 Tesing for Nonlinear Causaion beween Capial Inflows and Domesic Prices Abdul Rashid Inernaional Insiue of Islamic Economics (IIIE), Inernaional Islamic Universiy (IIU), Islamabad, Pakisan Absrac The nonlinear coinegraion and Granger causaliy ess are applied in a bi-variae framework o invesigae he effecs of capial inflows, moneary expansion and ineres raes on domesic price levels. The key message of he analysis is ha here is a significan inflaionary impac of capial inflows, money supply-o-gdp raio and domesic deb, in paricular during period of large capial inflows from 00 o 008. Whereas, ineres rae and exchange rae do no have any significan nonlinear causal links wih domesic price levels during he examined periods. JEL Classificaion: C3; F; F3 Keywords: Capial Inflows, Inflaionary Pressures, Moneary Expansion, Nonlinear Dynamics

3 . Inroducion In economics, any change ends o have boh posiive and negaive oucomes. Despie access o foreign funds in general and foreign direc invesmen (FDI) in paricular have helped o finance economic developmen and encouraged posiive growh exernaliies as increased in efficiency and a beer allocaion of resources, and associaed ransfer of echnology he abrup improvemen of he process of inegraion of emerging marke counries wih inernaional capial markes has brough problems for he hos economies. Some researchers have analyzed ha capial inflows creae some difficulies for he recipien counries in he form of real appreciaion of heir currencies. These difficulies include loss of compeiiveness by exporers, spending boom, asse marke bubbles, banking crises and he undermining of a sraegy o achieve moneary sabiliy by pegging he exchange rae. Effors o mainain a peg definiely imply ha he cenral bank mus inervene by absorbing he foreign exchange brough in by he capial inflows. However, such purchases increase he moneary base, generaing inflaionary dynamics. Capial inflows also may lead o he expansion of bank deposis and loans. Moreover, he expansion of bank balance shees owing o capial inflows may deeriorae he fragiliy of he banking sysem if bank supervision is no fully effecive. Sevens (006) addresses he consequences of capial inflows and appropriae moneary measures o conrol is effecs on Ausralian economy. He saed ha many open economy have perhaps less scope o allow large exchange rae moves wihou significan firs-round inflaionary or deflaionary effecs. Gupa (005) analyzed he effecs of financial liberalizaion on inflaion. His resuls indicae a posiive and saisical

4 significan associaion beween inflaion and financial repression. Musinguzi and Benon (00) discussed he managemen of inflows in Uganda. Using monhly daa and an Auoregressive Disribued Lag (ARDL) Approach o Coinegraion, hey concluded ha he capial inflows, nominal exchange rae and base money significanly and posiively drive he composie headline annual inflaion in Uganda in he long run. Gruben and McLeod (000) in heir sudy abou capial accoun liberalizaion and inflaion in he 990s address wo puzzles. The resuls sugges ha susained removal of one of he four resricions invenoried by he IMF can reduce average annual inflaion by as much as 3%. Taking ino accoun he above menioned heoreical as well as empirical facs, in his sudy, we herefore examine he nonlinear shor- and long-run causal linkages beween capial inflows, ineres rae, exchange rae and domesic price levels.. The Empirical Mehodology and Daa The KPSS (Kwiaowski e al. (99)) mehodology (he saisic) is used o es for he saionariy. Under his mehod, he null hypohesis is saionariy and he alernaive is he presence of a uni roo. This ensures ha he alernaive will be acceped (null rejeced) only when here is srong evidence for (agains) i. The KPSS es saisic (he saisic) is defined as follows : where S ˆ T s ( l) S is he parial sum process of he residuals are from a regression of he respecive variable on only inercep in case of level saionary, and on inercep and Criical values of he es saisic are based upon he asympoic resuls presened in KPSS (99, Table, p. 66). 3

5 rend in case of rend saionary; ha is defined as: S i i and s T l m T ( l) T T w( m, l), where w( m, l) is an opional weighing m m funcion; his is, w( m, l) m/( l), where l is he maximum lag. The nonlinear coinegraion es developed by Lin and Granger (004) is applied o explore he nonlinear long-run relaions beween he variables. The es is defined as follows: Le x be a linear inegraed process and y and x is called nonlinearly coinegraed wih funcion f provided u y f x ) has asympoic order smaller han hose of y and f (x). Lin and Granger (004) defined he following seps o es he null of nonlinear coinegraion agains of alernaive of no nonlinear coinegraion.. Idenify he possible nonlinear funcion for using Alernaive Condiional Expecaion (ACE) crierion (i.e., logarihm, exponenial, square roo, Box-Cox ransformaion, ec.).. Apply he Nonlinear Leas Square (NLS) mehod he esimae he parameers of he specified funcion. 3. Obain he residuals from he esimaed model and sore. 4. Apply KPSS es for esimaed residual o es he null of nonlinear coinegraion. Lin and Granger (004) said ha if he null hypohesis is specified as coinegraion, KPSS-es would give he righ disribuion under he null hypohesis and power approaching one as sample size grows under he alernaive. To examine he nonlinear shor-run causaliy, we use he Hrisu-Varsakkeis and Kyrsou (006) nonlinear Granger causaliy es know as he bivaraie noisy Mackey- ( 4

6 Glass model and is based on a special ype of nonlinear srucure developed by Kyrsou and Labys (006). The model is given below: c Y c Y Y c Y c Y Y Y N(0,) () N(0,) () where and Y are a pair of relaed ime series variables, he ij and ij are parameers o be esimaed, i are delays, c i are consans. The bes model () is ha allowing he maximum Log Likelihood value and minimum Schwarz informaion crierion. As menioned in Kyrsou and Labys (006, 007), and Kyrsou and Vorlow (007), he principle advanage of model () over simple VAR alernaives is ha he nonlinear Mackey-Glass (hereafer M-G) erms are able o capure more complex dependen dynamics in a ime series. The idenificaion of significan M-G erms in a pair of series reveals he nonlinear feedback law beween and Y and elucidae qualiaive feaures of his law. The es aims o capure wheher pas samples of a variable Y have a significan Y nonlinear effec (of he ype Y c ) on he curren value of variable. Tes procedure begins by esimaing he parameers of a M-G model ha bes fis he given series, using ordinary leas squares. To es reverse causaliy (i.e., from o Y), a second M-G model is esimaed, under he consrain 0. The laer equaion represens null hypohesis. Le ˆ, ˆ be he residuals produced by he unconsrained and consrained bes-fi M-G models, respecively. Nex, 5

7 compue he sums of squared residuals S c N ˆ N and S ˆ u. Le m is he number of free parameers in he M-G model and k is number of parameers se o zero when esimaing he consrained model, hen he es saisic is defined as S F S ( S u c S u ) / k /( N m ) F k, N m If he calculaed saisics is greaer han a specified criical value, hen someone rejecs he null hypohesis ha Y does no nonlinearly causes. Monhly daa over he span from 99 o 008 is used o explore he causal linkages beween ineres rae, capial inflows and inflaion rae. The main source of daa is he IMF s Inernaional Financial Saisics (CD-ROM). Our basic model consiss of nine variables. These variable are he log of marke ineres rae (line 60b and denoed by MR), he log of nominal exchange rae (line ae and denoed by LNER), he log of consumer price index (line 64 and denoed by LCPI), he raio of ne foreign asses o GDP (line 3n divided by line 90b and denoed by FAR), he raio of abroad money supply o GDP (lines 34 plus 35 divided by line 90b and denoed by MSR), and he log value domesic credi growh (line 3 and denoed by LDC). 3. Empirical Resuls The firs sep involved in applying coinegraion o explore he long-run associaion is o deermine he order of inegraion of each variable/series. More specially, he sudy esed wheher all he said variables are inegraed of order one, I (). Here, he domesic deb includes claims on general governmen (ne), claims on non-financial public enerprises, claims on privae secor, and claims on nonblank financial insiuions. 6

8 This was achieved by esimaing he KPSS uni roo es. The esimaed saisics of he KPSS ess for level and firs-difference series are presened in Table. Table : The KPSS Uni Roo Tes Resuls for Level Series (Jan. 990 o Dec. 008) Variables Levels KPSS (c) KPSS ( c ) ) Firs-Difference KPSS (c KPSS ( c ) Raio Form Variables FAR MSR Log Form Variables LCPI MR LNER LDC Noes: ADF(c) and ADF( c ) are he sandard ADF es saisics for he null of nonsaionary of he variable in he sudy wihou and wih a rend, respecively, in he model for esing. KPSS (c) and KPSS ( c ) are he KPSS es saisics for he null of saionary of he variable in he sudy wihou and wih a rend, respecively in he model for esing. The 0% and 5% asympoic criical values are -.57 and -.86 for ADF(c) respecively, and are -3. and -3.4 for ADF( c ) respecively. The 0% and 5% asympoic criical values are and for KPSS (c) respecively, and 0.9 and 0.46 for KPSS ( c ) respecively. * and ** denoe rejecion of he null hypohesis a he 0% and 5% significan levels, respecively. Since he esimaed es saisic, u, is greaer han he criical values for all he said series expec for he log change in manufacuring oupu, herefore, we rejec he null of saionariy in favor of he alernaive of uni roos, ha is, all he series have uni roos. However, if he deerminisic rends are presen in he series hen he rejecions of he hypohesis of level saionariy are no considered reliable. The sudy herefore proceeds o es he null hypohesis of saionariy around a deerminisic linear rend. The esimaed saisics are significanly greaer han criical values. Consequenly, he null hypohesis of rend saionariy is rejeced a any usual level of significance. However, he firs-difference of he series appears saionary. 7

9 The radiional coinegraion (says Johansen echnique, 990) and Granger causaliy (says Granger procedure, 986) ess are unable o find nonlinear causal relaions. We apply nonlinear coinegraion es developed by Lin and Granger (004) o explore he nonlinear long-run relaions beween he variables. To es he pairwise nonlinear coinegraion beween domesic price level and capial inflows, domesic deb, money supply-o-gdp raio, marke ineres rae and nominal exchange rae, we run a bivariae regression of LCPI on consan and BO-CO ransform of he said explanaory variables. Specifically, he funcion is expressed as follows: ( ) LCPI (3) where denoes explanaory variable. We run he nonlinear leas squares (NLS) mehod o esimae he underlying parameers (ˆ ), and hen apply he KPSS es o he residual o es he null hypohesis of nonlinear coinegraion agains an alernaive hypohesis of no nonlinear coinegraion. The esimaes are given in Table. The resuls provide srong evidence of he exising of nonlinear coinegraion beween domesic price level and ne foreign asses-o-gdp raio, money supply-o-gdp raio and domesic deb in boh he examined period. On he oher hand, he esimaion shows ha here is no significan nonlinear dynamic associaion beween domesic price level and boh marke ineres rae and nominal exchange rae. 8

10 Table : Pairwise Nonlinear Coinegraion Tess Variables included in Coinegraion Equaion Sample Period: January 990 o December 000 KPSS (c) KPSS ( c ) ) Sample Period: January 00 o December 008 KPSS (c KPSS ( c ) LCPI and FAR *.9 0.* LCPI and LDC 0.07** 0.098* 0.93** 0.7* LCPI and MSR ** 0.657* 0.* LCPI and MR LCPI and LNER KPSS (c) and KPSS ( c ) are he KPSS es saisics for he null of coinegraion wihou and wih a rend, respecively in he model for esing. The % and 5% asympoic criical values are and for KPSS (c) respecively, and 0.6 and 0.46 for KPSS ( c ) respecively. * and ** denoe rejecion of he null hypohesis a he % and 5% significan levels, respecively. To examine he nonlinear shor-run causaliy, we use he Hrisu-Varsakkeis and Kyrsou (006) nonlinear Granger causaliy es know as he bi-varaie noisy Mackey- Glass model. In firs sep, since he variables are nonlinearly coinegraed, he nonlinear VEC model is esimaed using he firs differences of he variables and error correcion erm by ordinary leas squares, in a specificaion ( 4 and c c ) seleced by Log Likelihood procedure wihou and wih resricion on lagged parameers of explanaory variable. Then we obain he residual o calculae he es saisics (says S ) F for esing nonlinear Granger causaliy beween he variables. The esimaed S F are repored in Table 3. The able clearly shows he nonlinear dynamic associaion beween domesic price level and capial inflows for he second sub-period and beween inflaion and domesic deb level and money supply o GDP raio for boh he sub-periods. The change in domesic price level (inflaion) is saisically significanly nonlinearly caused by he change in ne foreign asses-o-gdp raio during he second sub-period. For he firs sub- 9

11 period, however, he esimaes provide evidence o rejec he null hypohesis ha he change in ne foreign asses nonlinearly causes inflaion. For money supply-o-gdp raio and domesic deb, he analysis indicaes ha hey have significan nonlinear impac on inflaion during boh he examined periods. Finally, for marke ineres rae and nominal exchange rae, he able reveals ha hey do no have any nonlinear causal link wih inflaion in eiher period. Table 3: Pairwise Nonlinear Granger Causaliy Tess Direcion of Nonlinear Causaliy Sample Period: January 990 o December 000 Decision S F saisic ( a he 5% level) Sample Period: January 00 o December 008 Decision S F saisic ( a he 5% level) FAR LCPI Rejec Do no rejec LDC LCPI 3.83 Do no rejec Do no rejec MSR LCPI 4.47 Do no rejec.305 Do no rejec LNER LCPI.446 Rejec Rejec MR LCPI.38 Rejec 0.59 Rejec where he arrow poins o he direcion of nonlinear causaliy. 3. Conclusion The inenion in his paper is o invesigae he long-run and shor-run nonlinear dynamic ineracions beween domesic price level and capial inflows, money supply, domesic deb, manufacuring oupu, marke ineres and exchange raes. The esimaion indicaes ha here is highly significan nonlinear inegraion beween domesic price level and capial inflows and domesic deb in boh he periods. However, he domesic price level and marke ineres rae and nominal exchange rae are no coinegraed in eiher period. 0

12 The esimaes on he nonlinear Granger causaliy ess provide evidence of significan nonlinear Granger causaliy from capial inflows, domesic deb and money supply o domesic price level, whereas, ineres rae and exchange rae do no have significan nonlinear causal links wih domesic price level. The analysis suggess ha here is a need o manage he capial inflows in such a way hey should neiher creae an inflaionary pressure in he economy nor fuel he exchange rae volailiy. Serilizaion may be an effecive insrumen o limi he impac of foreign capial inflows upon domesic moneary base. In addiion, he SBP should pu some resricion on credi o boh governmen and privae secor, especially on nonproducive borrowing. The analysis may esablish useful base for fuure empirical work in his field and suggess ha researchers should also consider nonlineariy in modeling for inflaionary dynamics.

13 References Gupa, R., (005), Financial Liberalizaion and Inflaionary Dynamics: An Open Economy Analysis, Deparmen of Economics Working Paper Series, Universiy of Conneciu. Gurban, W. C. and Darryl M., (000), Capial Accoun Liberalizaion and Inflaion in he 990 s, Working Paper of Federal Reserve Bank of Dalls. Hrisu-Varsakelis, D., and Kyrsou, C., (006), Tesing for Granger Causaliy in he Presence of Chaoic Dynamics, Working Paper, Working Group on Economic and Social Sysem, Universiy of Macedonia, Thessaloniki, Greece. Kyrsou, C. and Labys, W., (006), Evidence for Chaoic dependence beween US Inflaion and Commodiy Prices, Journal of Macroeconomics, Vol. 8, No Kyrsou, C. and Labys, W., (007), Deecing Posiive Feedback in Mulivariae Time Series: The Case of Meal Prices and US Inflaion, Physica A, Vol. 377, No., 7-9. Kyrsou, C. and Vorlow, C., (007), Nonlinear Ineres Rae Dynamics, Journal of Macroeconomics, Forhcoming. Kwiakowski, D., P. C. B. Phillips, P. Schmid and Y. Shin, (99), Tesing he Null Hypohesis of Saionariy agains he Alernaive of a Uni Roo, Journal of Economerics, Vol. 54, Lin, J. and Granger, C., (004), Tesing Nonlinear Coinegraion, in COMPSTAT 004 Proceedings in Compuaional Saisics, ed. Jaromir Anoch, Springer-Verlag, Musinguzi, P. and Benon M., (00), A Monhly Model of Uganda s Equilibrium Real Exchange Rae (ERER) Pah, Inflaion, Oupu Gap and Expors: An Auoregressive Disribued Lag (ARDL) Approach o Coinegraion, Bank of Uganda Working Paper Series W/P/05/04. Sevens, GR, (006), Capial Flows and Moneary Policy Bullein Ocober 006, Reserve bank of Ausralia.