Testing for long-run stability - an application to money multiplier in India

In testing for a stable long-run relation between monetary aggregates and reserve money most previous studies have used the conventional tests for cointegration. Using the recently developped residual-based cointegration tests of Gregory and Hansen that explicitly allow for regime shifts, the present paper, contrary to the findings of previous studies, finds that there exists a stable, but time-varying, long-run relation between measures of money stock and reserve money in the Indian context. It also finds that the observed variation in cointegrating relations is better characterized by a discrete one-time shift, rather than a gradually evolving random walk process, attributable, probably, to discrete changes in monetary policy.