TITLE

The St. Louis Equation and Reverse Causation: the Evidence Reexamined

AUTHOR(S)
Mehra, Yash P.; Spencer, David E.
PUB. DATE
April 1979
SOURCE
Southern Economic Journal;Apr79, Vol. 45 Issue 4, p1091
SOURCE TYPE
Academic Journal
DOC. TYPE
Article
ABSTRACT
The major purpose of this paper is to examine the statistical exogeneity of the fiscal policy variables used in the St. Louis equation, and hence test the statistical adequacy of the St. Louis equation. It is shown that for the United States post war period, I 1952-IV 1974, in a distributed lag regression of nominal income on monetary and fiscal policy variables, the right-hand side policy variables are not strictly exogenous. But this endogeneity in the St. Louis equation is due not to the endogeneity of the monetary policy variable (monetary base) as widely believed but rather to the endogeneity of the fiscal policy variables (high employment government expenditures and high employment government receipts). Hence the empirical results presented in this paper do imply that, in spite of the strict exogeneity of monetary base, the reduced form distributed lag regressions of nominal GNP on monetary base and high employment government expenditures and receipts are still indeed mis-specified. The crucial statistical implication of "the reverse causation hypothesis" is that in a distributed lag regression of income on monetary and fiscal policy variables, the right-hand side policy variables are not strictly exogenous because of the contemporaneous correlation of the error term with the monetary policy variable. We have tested directly this statistical implication of the reverse causation hypothesis. The test results presented do substantiate the claim that the original St. Louis equation is not a true reduced form equation. However, this state of affairs is not due to the endogeneity of the monetary base (as asserted in the reverse causation hypothesis) but due to the endogeneity of the fiscal policy variables. The usual measures of fiscal policy such as high employment government expenditure and receipts systematically respond to changes in the level of nominal income.
ACCESSION #
4624834

 

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