Testing causality: Some caveats and a suggestion

Abstract The Granger concept of causality is defined within the framework of dynamic economic systems in terms of the predictability criterion. The concept has however been often wrongly applied to static systems. The test procedures for Granger causality due to Granger, Sims, Haugh and Pierce provide grossly inconclusive and often conflicting if not misleading results. These problems are illustrated with the data on profits and investment for Canada and the U.S.A. Further, it is suggested that the predictability criterion, if interpreted in terms of conventional forecasting methods, would enable us to provide more conclusive results. The problems assume added importance as the recent vintage of econometric modelling techniques heavily rely on these causality tests.

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