Causality and error correction in Markov chain : inflation in India revisited

Abstract

The present paper proposes certain statistical tests, both conceptually simple and computationally easy, for analysing state-specific prima facie probabilistic causality and error correction mechanism in the context of a Markov chain of time series data arranged in a contingency table of present versus previous states. It thus shows that error correction necessarily follows causality (that is temporal dependence) or vice versa, suggesting apparently that the two represent the same aspect! The result is applied to an analysis of inflation in India during the last three decades separately and also together based on the monthly general price level (WPI - all commodities) and 23 constituent groups/items, as well as on the three consumer price index (CPI) numbers. Keywords: Markov chain; Steady state probability; India; Inflation; Return period. JEL Classification: E31, C1