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Abstract
The relationship between growth in monetary aggregates and price changes
continues to be a subject of considerable debate both in the academic and policy
circles. Whereas the more ‘conservative’ policy makers hold that growth in monetary
aggregates bear proportionately on prices, ‘liberals’ on the other hand suggest a
fairly weak relationship and instead mainly attribute sustained price changes to
other innovations (including structural weaknesses and poor productive capacity).
This study employed vector autoregression techniques (and its variants) to examine
both short term as well as long term interactions between selected macroeconomic
aggregates with particular focus on the relationship between money growth and
price changes. Results from both the reduced form vector autoregression
specification and the contemporaneous structural vector autoregression show a
weak causation from growth in monetary aggregates to price changes, but the link
between changes in monetary aggregates and prices becomes stronger in the long
run. The results also point to a strong relationship between price changes on the one
hand and exchange rate depreciation, and past inflation outcomes on the other. The
results imply a potential for increased revenue from monetisation, at least up to
some feasible as well as the need to focus on other possible sources of price
variations.
In general, whereas it is possible for the relationship between prices and money to
weaken, budget deficits beyond ‘certain financeable limits’ will clearly negate the
possibility of attaining other objectives of macroeconomic policy...