Empirical tests to discern the dynamic causal chain in macroeconomic activity: New evidence from Thailand and Malaysia based on a multivariate cointegration/vector error-correction modeling approach

The primary aim of this paper is to make an initial attempt to conduct empirical tests in order to discern the dynamic causal chain - in the Granger (temporal) sense rather than in the structural sense - among real output, money, interest rate, inflation, and the exchange rate in the context of two small Southeast Asian developing economies, such as Thailand and Malaysia. The methodology employed uses various unit root tests and Johansen's cointegration test followed by vector error-correction modeling, variance decompositions, and impulse response functions in order to capture both the within-sample and out-of-sample Granger-causal chain among macroeconomic activity. Given the relatively stable macroeconomic environment in these two growth-oriented economies, the results, quite in line with our expectations, tend to suggest that in the Granger-causality sense, money supply (particularly M1) appears to have played the leading role of a policy variable being the most exogenous of all, and the other variables including output, rate of interest, exchange rate, and prices appear to have borne most of the brunt of short-run adjustment endogenously in different proportions in order to re-establish the long-run equilibrium. The Granger-causal chain implied by our evidence that money supply (particular M1) more often predominantly leads (rather than lags) output and the other three endogenous variables, is consistent more with the Keynesian (in the case of Thailand) and the Monetarist (in the case of Malaysia) than with the recent Real Business Cycle macroeconomic paradigm. This finding has clear policy implications in the sense that, as long as there is stability and continuation of economic policies (regardless of change of governments) within the framework of a proper macroeconomic discipline (implying thereby an expectation-augmented supply curve being not completely vertical), a monetary expansion in a small developing economy will not necessarily be dissipated merely in terms of higher nominal variables (such as prices, exchange rates, or interest rates) but will contribute positively to assist in achieving an impressive rate of economic growth, as happened in both Thailand and Malaysia for the major part of the period under review.