View metadata, citation and similar papers at core.ac.uk brought to you by CORE provided by Research Papers in Economics International Journal of Applied Econometrics and Quantitative Studies. Vol.1-1(2004) A COMPARISON OF CAUSALITY TESTS APPLIED TO THE BILATERAL RELATIONSHIP BETWEEN CONSUMPTION AND GDP IN THE USA AND MEXICO GUISAN, M.Carmen* Abstract Bilateral causality between Private Consumption and GDP in the USA and Mexico during the period 1960-2002 is analysed comparing Granger´s test, a modified version of Granger´s test, cointegration, TSLS and Hausman´s causality test. The main conclusion is that the modified version of Granger´s test performs better than the unmodified version, and also better than cointegration, to accept lagged causality in the Consumption equation. Besides that Hausman´s test is very often more useful to distinguish between bilateral and unilateral contemporaneous causality than TSLS. We conclude that there is a high degree of causal dependence of Private Consumption on GDP and a lower dependence in the case of the reverse relation. JEL classification: C5, C52, E2, O51, O57 Key words: Granger´s test, causality test, Mexico, the USA, Consumption and Gross Domestic Product, Consumption Models 1.- Introduction In this study we analyse bilateral causality between Private and Total Consumption and GDP in Mexico and the USA with the following methods: Granger´s causality test, modified version of Granger´s causality test proposed by Guisan(2003), cointegration, Two Stage Least Squares, and Hausman´s test. * Maria-Carmen Guisan is Professor of Econometrics and Director of Master in International Sectoral Economics at the University of Santiago de Compostela (Spain), http://www.usc.es/economet/guisan.htm, e-mail [email protected] 115 Guisan, M.C. A Comparison of Causality Tests between consumption and GDP in … In previous studies, such as Guisan(2001), the analysis of the cointegration relationship between real Private Consumption and GDP in 25 OECD countries was performed, with results that show several limitations of that approach. A simple method based on a regression approach by means of a mixed dynamic model with three explanatory variables was clearly more successful to reach right decisions in the distinction between true and spurious relationships. In Guisan(2003) some comparisons of causality tests where performed with data of several OECD countries. This article is an extension of that paper, with applications to Mexico and the USA. In section 2 we present a general comparison of the evolution of Consumption and GDP in the USA and Mexico during the second half of the 20th century, expressed in thousand dollars of 1990 per inhabitant at Purchasing Power Parities, PPPs. In section 3 we analyse bilateral direction of causality between these variables with Granger´s causality test, both with the unmodified and the modified versions of this test, and with cointegration tests. In section 4 bilateral and contemporaneous causality is analysed following the Cowles Commission approach of contemporaneous interdependence by applying TSLS and Hausman´s test of causality. Finally in section 5 we present the main conclusions, which show that the contemporaneous relationship between these variables is mainly unilateral, with Consumption depending strongly on GDP, and that the reverse relationship holds more slightly. The best test to account for this was Hausman test, while the other methods are helpful but more limited for causality analysis purpose. 2.- Evolution of real Consumption and GDP per inhabitant in Mexico and the USA, 1960-2002. Graph 1 shows the evolution of total real Consumption per inhabitant, both private and public, in Mexico and the USA for the period 1960-2002, expressed in thousand dollars at 1990 pric es and purchasing power parities, PPPs. We can notice that the increase of this variable in Mexico has been moderately positive during that period in comparison with the high increase in the USA. 116 International Journal of Applied Econometrics and Quantitative Studies. Vol.1-1(2004) Graph 1. Evolution of total Consumption per inhabitant (thousand dollars at 1990 prices and PPPs) 24 US A 20 16 12 U SA 8 M x 4 M x 0 1960 2002 This evolution is explained by the evolution of real Gdp per inhabitant, PH. Table 1 shows the evolution of private,CH, and public, GH, consumption per inhabitant and PH in both countries. Table 1. Consumption and GDP per inhabitant in Mexico and the USA (thousand dollars at 1990 prices and PPPs) Country Variable 1960 1985 2002 Mexico CH 2.373 3.987 4.735 GH 0.160 0.515 0.485 ZH 2.533 4.502 5.220 PH 3.202 5.949 6.809 USA CH 7.443 13.513 18.719 GH 2.790 3.601 3.997 ZH 10.232 17.114 22.716 PH 12.359 20.321 26.770 Source: Own elaboration from OECD National Accounts Statistics. Note: CH is Private Consumption, GH is Public Consumption, ZH is total Consumption, ZH=CH+GH, and PH is Gross Domestic Product, all variables in thousand dollars per inhabitant. 117 Guisan, M.C. A Comparison of Causality Tests between consumption and GDP in … Graphs 2 and 3 show the high positive correlation existing between total consumption per inhabitant, ZH, and Gdp per inhabitant, Ph, in Mexico and the USA. Graph 2. Total Consumption and GDP in Mexico (thousand dollars per inhabitant at 1990 prices and PPPs) Z H M P P v s . P H M P P 5.5 5.0 4.5 P P 4.0 M H Z 3.5 3.0 2.5 3 4 5 6 7 8 P H M P P Graph 3. Total Consumption and GDP in the USA (thousand dollars per inhabitant at 1990 prices and PPPs) Z H U v s . P H U 24 22 20 18 U 16 H Z 14 12 10 8 12 14 16 18 20 22 24 26 28 P H U Although the average annual rate of growth of Gdp in Mexico during the period 1960-2002, 4.27%, was higher than that of the USA, 2.95%, the average annual rate of Population growth was much higher in Mexico, 2.47%, than in the USA, 1.11%. As a consequence the 118 International Journal of Applied Econometrics and Quantitative Studies. Vol.1-1(2004) average rate of growth of Gdp per inhabitant was similar in both countries: 1.80% in the case of Mexico and 1.84% in the case of the USA, because the exponential rate of growth of a ratio between two variables is the difference between both rates. The level of CH in Mexico in year 2002 is only a 25% of the value of this variable in the USA, GH is only a 12%, and PH a 38%. Regarding the value of PH in Mexico there are some discrepancies among different statistical sources, amounting 7.0 thousand dollars of 1990 in the year 2000, accordingly to data elaborated from OCDE National accounts and to 7.5 in the same year accordingly to data elaborated from Maddison´s estimation for 1998 and the rates of growth for Mexico in the OECD statistics for the following years. In any case data of Ph in Mexico in year 2000 is similar to that of the USA in year 1940, and thus the level of consumption is too much low in Mexico in comparison with social expectations. Policies to reach higher levels of these variables in Mexico should be addressed to increase human capital and industrial development according to the analyses made by Canudas(2001), Dussell(2002), Guisan, Malacon and Exposito(2003), and other authors. Graph 4 presents the evolution of real Gdp per inhabitant in the USA, Mexico, Latin America and Ireland. This country is included in the comparison to show how human capital and industrial development, among other factors, have made possible a fast development during the last two decades of the 20th century, while Mexico and Latin America show during that period a clear stagnation in per capita terms. Data are based on historical statistics, Maddison(2001) and OECD National Accounts. The countries with higher level of economic development during the second half of the 20th century are generally those with moderate rates of population growth and high level of industrial production per inhabitant. High educational levels of population and free market institutions and incentives to invest in productive activities, have usually been a positive starting point to get a dynamic an sustained 119 Guisan, M.C. A Comparison of Causality Tests between consumption and GDP in … process of economic development, as it is shown in Guisan, Aguayo and Exposito(2001). Graph 4. Evolution of real Gdp per inhabitant (thousand dollars at 1990 prices and PPPs) 28 24 U S A 20 I r 16 12 8 M x 4 L a t i n A m e r i c a 0 00 10 20 30 40 50 60 70 80 90 00 Mexico have experienced important increases in GDP but excessively high rates of Population growth during the second half of the 20th century, and as a consequence a moderate growth of real GDP per inhabitant. In the last decades of that century the education level of population has been increased and that is positive for further development. 3. Granger´s causality test, modified version of Granger´s test and cointegration. Here the estimations are performed with data of Consumption per inhabitant, CH, and Gdp per inhabitant, PH, expressed in purchasing power parities of 1990, PPPs, and per capita terms, based on OECD National Accounts Statistics and Maddison(2001). In the Annex we include data for the period 1970-2002.