The purpose of this study is to attempt to analyze Granger causality in the frequency domain framework between producers' prices measured by wholesale price index (WPI) and consumers' prices measured by consumer price index (CPI) in the context of India.
Analysis was carried out in the framework of time series and for analysis Johansen and Juselius's maximum likelihood approach for cointegration was applied after confirming that variables are integrated of order one, i.e. I(1) through the Lee and Strazicich unit root test. Finally, Granger causality was tested in the frequency domain by utilizing a recently developed approach of Lemmens et al. over the period January 1957‐February 2009.
The paper finds that CPI Granger cause WPI at a lower, intermediate as well as higher levels of frequency, reflecting very long‐run, intermediate as well as short‐run cycles. By contrast WPI Granger cause CPI at 5 percent level of significance was found at intermediate frequencies, reflecting significant intermediate cycles.
The study reveals that CPI is a leading indicator of producers' prices and inflation (i.e. WPI). This gives an indication that Indian policy analysts ought to control for factors affecting CPI in order to have control on WPI since WPI is used for making various macroeconomic indicators in real terms.
The main contribution of the paper is to show the evidence of bidirectional causality between WPI and CPI. Furthermore, use of a recent approach developed by Lemmens et al. for Granger causality in the frequency domain in this study is also relatively new. To the best of the author's knowledge there is no such study in this area either for developed or developing economy to date.
