Testing long-run neutrality of money in Slovakia

• Thesis title in Czech: Testování neutrality peněz: Případ Slovenska
• Thesis title in English: Testing long-run neutrality of money in Slovakia
• English key words: long-run money neutrality, monetary policy, inflation, unit root, money supply, cointegration
• Academic year of topic announcement: 2022/2023
• Thesis type: Bachelor's thesis
• Thesis language: angličtina
• Department: Institute of Economic Studies (23-IES)
• Supervisor: PhDr. Jaromír Baxa, Ph.D.
• Author: hidden - assigned by the advisor
• Date of registration: 23.06.2023
• Date of assignment: 23.06.2023

References

FISHER, M., & SEATER, J. (1993): “Long-run neutrality and superneutrality in an ARIMA framework.” American Economic Review 83(1), pp. 402-415.

WEBER, A. (1994): “Testing long-run neutrality: Empirical evidence for G7 countries with special emphasis on Germany.” Carnegie-Rochester Conference Series on Public Policy 41(1), pp. 67-117.

LUCAS, R.E. (1972): “Expectations and the Neutrality of Money.” Journal of Economic Theory 4(2), pp. 103-124.

LUCAS, R.E. Jr. (1996): “Nobel lecture: monetary neutrality.” Journal of Political Economy 104, pp. 661-682.

SERLETIS, A., & KOUSTAS, Z. (1998): “International Evidence on the Neutrality of Money.” Journal of Money, Credit and Banking 30(1), pp. 1-25.

ERFANI, A. & SAMIMI, J.A. (2004): “The test of neutrality and superneutrality of money in the Iranian economy.” Journal of Economic Research 67, pp. 117-138.

DEEV, O. & HODULA, M. (2016): “The long-run superneutrality of money revised: the extended european evidence.” Review of Economic Perspectives 16(3), pp. 187-203.

BULLARD, J.B. (1999): “Testing long-run monetary neutrality propositions: Lessons from the recent research.” Federal Reserve Bank of St. Louis Review 81, pp. 57-77.

NORIEGA, A.E. (2004): “Long-run Monetary Neutrality and the Unit-Root Hypothesis: Further International Evidence.” North American Journal of Economics and Finance 15 (2), pp. 179-197.

Preliminary scope of work in English

Research question and motivation

The main motivation of this thesis would be to examine the monetary proposition that changes in money supply are not accompanied with the permanent changes in real output.

In other words, my research question is whether the changes of the two monetary aggregates, M1 and M2, have no significant influence on the development of real variables in the long run. Therefore, variables like real interest rate or real wages would stay unchanged once liquidity is injected into the economy, affecting only nominal variables.

The reason why neutrality of money is an important topic in macroeconomics discussed since the 16th century is because its relation to effectiveness of monetary policy. In Slovakia, the National Bank of Slovakia has the main responsibility to promote price stability which is the major objective of monetary policy. National Bank of Slovakia participate in common monetary policy which the European Central Bank sets for the euro area and adopts different monetary policy frameworks. Therefore, I believe that it is beneficial to test the effectiveness of those monetary policy tools before adopting them.

The literature regarding the long-run money neutrality have increased in the last decades, mainly because it is necessary to investigate the neutrality of money in the economy of every country in order to figure out the effectiveness or ineffectiveness of monetary policy. Deev and Hodula (2016) examined the superneutrality of money of 29 European countries, Puah (2008) investigated LRN using the data of 13 Asian developing countries, Najafi (2021) was interested in LRN in the service sector of the Iranian economy. For each of those countries, the results differ.

To conclude, the overall objective of this thesis would be to determine the effect of the money supply (represented by M1 and M2) on the real variables (represented by real output) in the long run in Slovakia.

Contribution

The aim of this thesis is to contribute to the existing literature and to broaden the existing research on money neutrality testing.

So far not a lot of research has been done regarding money neutrality in Slovakia. In the Bulletin of Monetary, Economics and Banking authors published a paper investigating long-run money neutrality in Indonesia, in which they rejected the hypothesis (Arintoko, 2011). In another paper by Ugwu, Ehinomen, Nwosa and Efuntade (2021), researchers came to the same conclusion in Nigeria. Samimi and Erfani (2021) investigated money neutrality in Iran, concluding that money are in fact neutral, same for Sanchez Fung (2010) in Dominican Republic. It is therefore beneficial for every country to construct its money neutrality test to define the effectiveness or ineffectiveness of monetary policies.

Therefore, I believe that this thesis could be a contribution to the existing research and result in better understanding of the concept of money neutrality. Secondly, it might provide an incentive for future research.

Methodology

This thesis would make use of annual time-series data for money supply (represented by M1 and M2) and real GDP (representing real output) extracted from the National Bank of Slovakia and the Statistical Office of the Slovak Republic.

To test money neutrality, the Fisher-Seater model is frequently used. This ARIMA model consists of two variables, money supply and real GDP, both in logarithmic form. Fisher-Seater model requires that in long-run neutrality testing, all variables are integrated in the same order. Therefore, an important step regarding the data is unit root test. To do this, Dickey-Fuller test is frequently used. For the purpose of the analysis, we must also evaluate cointegration tests.

Outline

Abstract

Introduction
1. Why is money neutrality a freguently discussed, important and significant economic phenommenon.
2. Overview of existing reseach and previous long-run money neutrality tests and their results in other countries.
3. How I add to existing research and why we think it is beneficial to do money neutrality testing in Slovakia.
4. Main results of the testing.
5. Organisation of my bachelor thesis.
Literature review and theorethical foundations
1. Money in different schools (Classical school, Keynesian school, Monetarism).
2. The quantity theory of money.
3. Literature review.
4. What hypothesis is gonna be tested.
Methodology
1. Variables and data description.
2. Fisher-Seater methodology (detailed description).
3. Unit root tests.
4. Cointegration test.
Results
1. The test results of LRN.
2. Discussion and broader interpretation of results.
Conclusion
1. Implications of the test results for the policy tools.
2. Suggestion for future research.