154 Journal of Reviews on Global Economics, 2016, 5, 154-164 E-ISSN: 1929-7092/16 © 2016 Lifescience Global Causality between Monetary Expansion and the Price Level in India since 1950s – A Re-Examination Sanjib Debnath and Ritwik Mazumder * Department of Economics, Assam University, Silchar, Assam 788011, India Abstract: This paper has tested short run causality between broad money supply and whole-sale price index (WPI) in India during 1951-2013 adopting a Toda-Yamamoto (1995) modified Granger causality approach under a VAR environment. Exponentially detrended annual time series data on broad money supply and the whole-sale price index are used for this purpose. Alternative tests for structural breaks reveal significant but dissimilar breaks in the variables. The empirical results are suggestive of a uni-directional causality from broad money supply to WPI. The study further finds that broad money supply and WPI in India have a long-run co-integrating relationship and short run causal relations could hence be expected. Keywords: Broad money supply, WPI, Modified Granger Causality, Toda-Yamamoto (1995) and VAR. 1. INTRODUCTION Over the years, empirical studies on monetary expansion and inflation or between money supply and the price level have received significant attention in developing countries. This is perhaps because most of these nations today have a significant poor population and a burgeoning middle class and inflation hurts these groups the most. Consequently the key policy objective of both monetary and fiscal authorities in such countries is to control inflation (i.e., maintain price stability) without jeopardising the growth potentials. The monetary authorities truly recognise both the theoretical and empirical validities of money supply – price level inter-linkage which compels them to adopt tighter monetary policies during periods of high inflation. Further welfare states are aware about the social and economic costs of inflation which motivate them to fix price stability as the primary goal of macroeconomic policy. Price volatility creates uncertainties, lowers the real returns to savings and investments, and is detrimental for economic growth. The literature on money-inflation nexus in India recognizes that unwarranted growth of money supply has been one of the key factors behind the inflationary spells experienced since the 1950s. Monetary expansion or increase in money supply was triggered by central government borrowings from the Reserve Bank of India (Pattnaik and Samantaraya 2006; Reddy 1999). Indian economists maintain that the factor primarily accountable for the excessive growth of money supply and thus inflationary spells experienced in India, has been the large scale resort to deficit financing by the central government. This argument led *Address of correspondence to this author at the Department of Economics, Assam University, Silchar, Assam 788011, India; Tel: 91-03842-270853; Fax: 91-03842-270802; E-mail: r_itwikm@yahoo.com JEL Classification: C32, E50, E52, E59. to the discontinuation of automatic monetisation of debt by the RBI since 1997. Among the significant empirical contributions in this area for the Indian economy in recent years, the studies by Rangarajan and Arif (1990), Jadav and Singh (1990), Srimany and Samanta (1998), Parida et al. (2001), Rangarajan (2001), D’Souza (2003), Mohan (2008), Mishra and Mishra (2009), Singh and Kalirajan (2006 and 2007) are important in view of their economic as well as methodological robustness. However short period analyses in the above studies may question the statistical reliability of the test results as because multiple business cycles across decades are not captured. The present study however focuses entirely on testing for short run causality between broad money supply and whole-sale price index (WPI) in India during 1951-2013 adopting a Toda-Yamamoto (1995) modified Granger causality approach under a VAR environment. In particular the study examines whether broad money supply expansion has been inflationary in India. Exponentially detrended annual time series data on broad money supply and the whole-sale price index are used. Structural break unit root tests along with structural break dates are also determined. The paper is written in the following sections. After a brief introduction to issues relating to money-inflation nexus in India in section 1, data sources and econometric issues are discussed in section 2. Section 3 presents the analysis of empirical results, followed by a very brief summary and conclusions in section 4. 2. METHODOLOGY AND DATA 2.1. Variable Selection and Detrending The direction of causality between money and prices is justified by the monetarist school. The