Effects of simultaneity on testing Granger-causality – a cautionary note about statistical problems and economic misinterpretations

Interpreting Granger causality as economic causality implies that the underlying VAR model is a structural economic model. However, this is wrong if simultaneity occurs. Magnitude and stability of possible errors are analysed in a simulation study. It is shown that economic misinterpretations of tests of Granger causality can occur with probability one for realistic parameter values. Furthermore, the power of the test can be rather low even with a sample size of T=50.