Dynamic Relationships between Macroeconomic Variables: An Empirical Application for Turkey

Abstract

This study investigates the causal relationships among macroeconomic variables such as output growth, money supply, inflation and exchange rate in Turkey for the period 2005Q1-2015Q2. Especially, it examines the impact of monetary policy on macroeconomic variables to sustain economic growth by using Johansen Cointegration Test, Vector Error Correction Model (VECM) approach, Granger Causality Test, Impulse-Response Functions and Variance-Decompositions of VECM and the simplified Ordinary Least Squared(OLS) Regression. The findings of the study indicate that a long term relationship exists among output growth (GDP), money supply (M1), inflation (INF) and exchange rate (EXCR). Furthermore, money supply (M1) has a significant effect on output growth (GDP). According to the results of causality test, there is a unidirectional long term causality relationship from money supply (M1) to output growth (GDP), from output growth (GDP) to inflation (INF), from exchange rate (EXCR) to inflation (INF). Furthermore, results show that there is bidirectional causality relationship between money supply (M1) and inflation (INF). Consequently, the findings of the study indicate that if the main object of the government policy is to maintain high economic growth, an economic reform including monetary policy and inflation targeting will be the most available step.

Keywords: VECM model, the johansen cointegration, the granger causality, impulse-response functions, variance decomposition, macroeconomic variables