THE RELATIONSHIP BETWEEN MONEY SUPPLY AND INFLATION: ANALYSIS WITH PANELVAR APPROACH

Year 2023, , 73 - 75, 15.01.2024

Esengül Özdemir Altınışık , Başak Tanınmış Yücememiş

https://doi.org/10.17261/Pressacademia.2023.1855

Abstract

Purpose- Central banks serve as institutions responsible for executing monetary policy in countries, with the primary objective of managing the money supply and ensuring price stability in the economy. These institutions formulate and implement monetary policies, controlling interest rates, maintaining price stability, managing exchange rates, and overseeing the banking sector. Through the use of both traditional and modern tools, such as policy interest rates, reserve requirements, rediscount policies, and open market operations, central banks aim to uphold stability in the economy and financial system. The economic literature extensively explores the theoretical and empirical effects of central banks' expansive and contractionary policies on inflation. This study specifically investigates the practices of selected country central banks regarding monetary policy, with a focus on understanding the relationship between money supply and inflation. The objective is to unveil the impacts of these policies on countries' macroeconomic variables and identify determinants influencing the selection of effective policies and tools in central banks' pursuit of price stability-oriented monetary policy practices.
Methodology- One of the tools central banks employ to intervene in the market is the manipulation of the money supply, influencing macroeconomic variables through expansive and contractionary policies. This study analyzes the impact of central banks' monetary policies using PanelVAR analysis for the period 2005–2022. The initial model features inflation as the dependent variable, while independent variables include money supply, policy interest rates, growth, current account deficit, budget deficit, and unemployment. These variables are modeled as annual percentage changes, with the money supply variable included as a level value after logarithmic transformation. Subsequent models are constructed with each independent variable as the dependent variable, adhering to the assumptions of VAR models. To address the stationarity condition of unit roots, cross-sectional dependencies in panel data series are tested. Following the identification of cross-sectional dependency issues, second-generation unit root tests are applied. After stationary analyses, VAR analysis is conducted, cointegration vectors are identified, and error correction models are established for further analysis. Finally, impact response analysis determines the size of the effects of the macroeconomic variables used in the analysis, and Granger causality analysis is applied to ascertain the direction of causality.
Findings- In the model for controlling the money supply, the alternative hypothesis is accepted, supporting a statistically significant relationship or a cause-and-effect relationship among policy interest rate, growth, inflation, unemployment rate, current account deficit, and budget deficit variables. In the analysis where inflation is the dependent variable, long-term cointegration between money supply, inflation, and policy interest rate is identified. There is a bidirectional causal relationship between the money supply variable and inflation and policy interest rate. A causality relationship from the current account deficit variable to the money supply is determined, but causality from the money supply to the current account deficit variable cannot be established. Causality relationships are identified between policy interest rate and inflation, money supply, growth, and current account deficit variables, with the direction of the relationship being from inflation to policy interest rate, from growth variable to policy interest rate, and from the current account deficit variable to policy interest rate. A bidirectional causality relationship is found between unemployment and growth variables, and a unidirectional causality relationship from inflation.
Conclusion-The formulation of monetary policy within the framework of country dynamics, specifically through policy interest rates and inflation, ensures measured responses from other macroeconomic variables. Conscious management of the long-term cointegration between money supply, inflation, and policy interest rate plays a crucial role in effectively managing the economy. A unit shock applied to the money supply variable has a prolonged impact on inflation, lasting for 12 periods without damping.

Keywords

Money supply, inflation, monetary policy, central banks, PanelVAR

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