Testing Long-run Neutrality: Empirical Evidence for G7 Countries with Special Emphasis on Germany

Modern neo-Keynesian, new classical, and real business cycle models typically differ in the degree to which they incorporate long-run or short-run neutrality propositions. Despite their importance, little firm international evidence on the validity of these neutrality hypotheses is available to date. This paper applies a bivariate VAR approach to test the long-run restrictions implied by a number of neoclassical neutrality propositions. The evidence from the G7 countries appears to be consistent with the long-run neutrality of money and the vertical Phillips curve, but the data largely refute the long-run super-neutrality of money and the `Fisher effect' of inflation on interest rates.