On causality and the monetary approach to the balance of payments: The European experience

Using Sims causality test it is shown that the negative relationship between the rate of domestic credit creation and the rate of change of foreign exchange reserves is consistent with the direction of causality proposed by the monetary approach to the balance of payments and it is not simply the result of central bank sterilization or private bank credit policy. Evidence of such opposite causality is present in Sweden and the United Kingdom but it is part of a two-way feedback structure still consistent with the monetary approach.