Measuring the Long-Term Relationship between the Money Supply (M2) and Public Spending, and its Impact on Economic Growth

Abstract

This study focuses on analyzing the causal relationship between selected macroeconomic variables—namely public expenditure, money supply (M2), and economic growth in Iraq—over the period 1988 to 2014. The research employs modern econometric techniques such as time series analysis, cointegration tests, the two-step Engle-Granger methodology, and the Johansen-Juselius cointegration and error correction approach, in addition to Granger causality tests. The study aims to address key questions: Is there a causal relationship between these variables and economic growth in Iraq? What is the nature and direction of these relationships? Which variable has the most significant impact on growth rates?

To answer these questions, the study is based on several hypotheses, the most important of which is the existence of a long-run, bidirectional relationship between the selected variables and economic growth, with the specific nature of the Iraqi economy playing a major role in shaping this relationship.

The study arrives at several important findings, including:

• The growth trajectory of the Iraqi economy exhibits significant volatility during the study period (1988–2014), reflecting the fragile structure of the economy and its dependence on limited and rapidly changing resources, which hinders the sustainability of growth.


• Despite a notable increase in both public expenditure and growth rates, the money supply (M2) proved to be the most volatile variable and the most influential in determining growth rates.


• The results show a unidirectional causal relationship from public expenditure to money supply (M2), but not the reverse. Meanwhile, a bidirectional (reciprocal) causal relationship was found between money supply (M2) and gross domestic product (GDP).


• The study reveals an important empirical insight: the rentier nature of the Iraqi economy accounts for the deviations from conventional economic theory regarding the relationship between these variables and GDP.

Based on these findings, the study recommends improving the management of these macroeconomic variables through structural reforms, enhancing their role in stimulating economic growth, implementing fiscal reforms to support future growth prospects, and exerting greater efforts to mitigate external shocks by diversifying income sources within the Iraqi economy.

Keywords:  Broad Money Supply (M2), public spending, Economic Growth.