THE RELATIVE EFFECTIVENESS OF MONETARY AND FISCAL POLICIES An Econometric Study

This paper develops a multivariate model to test the effectiveness of monetary and fiscal policy for the economic growth in five Asian Countries (Pakistan, India, Thailand, Indonesia and Malaysia). Most of the previous studies in this area have paid less attention to stationarity, cointegration and causality issues. The series M1 (Money Stock), Government Expenditure, GDP and exports are tested for time series properties. It is found that the series are non-stationary in their levels but stationary at the difference and hence can be cointegrated. Cointegration analysis shows that long-run relationship exists among the variables. Having established the fact of long-run relationship we further extend our analysis to focus on the causal relationship among the variables. On applying Granger Causality Test two problems were met. One is the choice of optimum lag and second is that the standard Granger or Sims tests results provide invalid causal inferences, as error-correction terms are omitted in these tests. To overcome the issue concerning optimal lag length the minimum final prediction criterion suggested by Hsiao is used, the order in which the variables entered into the model is also considered by using specific gravity criterion (SGC) proposed by Canies and Sethi. This criterion also provides temporary causal inferences between the variables. The second problem is avoided by applying alternative tests for Granger causality based on error correction model. The results show that there exists a strong bi-directional causality between fiscal policy and economic growth and also between monetary policy and economic growth for Thailand. In the case of Indonesia we observed a unidirectional causality between monetary policy and economic growth and a unidirectional causality between fiscal policy and economic growth. Estimation results for Malaysia show only unidirectional causality between the variables representing both of the policies and economic *The authors are Project Economists at Applied Economics Research Centre, University of Karachi, Karachi-75270 (Pakistan). 94 Pakistan Economic and Social Review growth. In the case of Pakistan, monetary policy is found to be influencing economic growth. While for India study found out a unidirectional causality between monetary policy and economic growth.