a paper on policy effectiveness

8/14/2019 A Paper on Policy Effectiveness

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Masters in International Economics and Finance

Faculty of Economics,

Chulalongkorn University, Phayathai Road,

Bangkok-10330,Thailand.Tel: (662) 218 6295, (662) 218 6218,Fax:(662) 218 6295,

E-mail: [email protected], http://www.econ.chula.ac.th/programme/ma_inter.html

Paper#4

Application of the simulation models

2940605: Quantitative Methods in Economic Analysis

BY

SK. ASHIQUER RAHMANID#4585974929

A Thesis Submitted In Partial Fulfillment of the Requirement for the Degree of Masters in

International Economics and Finance

TO,

DR.BANGORN TUBTIMTONGASSISTANT PROFESSOR

A PaperOn

How Effectiveness of the Fiscal and Monetary Policy to

the Growth Rate of National Income Expansion?


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Wilsdcats Activities 2002

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Letter of Transmittal June 15, 2002

Dr.Bangorn TubtimtongAssistant Professor,Masters in International Economics and FinanceFaculty of Economics,Chulalongkorn University,Phayathai Road, Bangkok, Thailand

Subject: Letter of Transmittal.

Dear Madam,

Here is my paper on " How effectiveness of the fiscal and monetary. that I was assigned. Itwas a great opportunity for me to acquire practical knowledge of the Quantitative Methods in

Economic Analysis and forecasting

I have concentrated my best effort to achieve the objectives of the report and hope that my

endeavor will serve the purpose.

I believe that the knowledge and experience I have gathered during my paper preparation will

immensely help me in my professional life. I will be obliged if you kindly approve this effort.

Sincerely yours

Sk. Ashiquer Rahman

Id#4585974929

Masters in International Economics and FinanceBangkok, Thailand


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Preface Any institutional education would not be completed if it were confined within theoretical

aspects. Every branch of education has become more competed by their practical application

and accomplishment of full knowledge. We shall be benefited by our education if we can

effectively apply the institutional education in practical fields. Hence, we all need practical

education to apply theoretical knowledge in real world. By considering this importance faculty

of economics arranges the Quantitative Methods in Economic Analysis courses for the

students of Masters in International Economics and Finance. As a part of this program my

topic was selected as how effectiveness of the fiscal and monetary.

I tried my best to conduct an effective study by arrange and analysis data. There may be some

mistakes, which are truly unintentional. So, I would request to look at the matter with merciful

mind.

Sk. Ashiquer RahmanId#4585974929Chulalongkorn UniversityMasters in International Economics and FinanceBangkok, Thailand


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AcknowledgementFirst, all praises go to almighty Allah, the most gracious, the most merciful to give me the ability for

all these I have done.

Then I would like to thank Ms. Wanwadee Wongmongkol. Now I would like to thank

Dr.Bangorn Tubtimtong Assistant Professor, Chulalongkorn University, Phayathai Road,

Bangkok,Thailand to give me the opportunity to do this project.

I would also like to thank Professor. Paitoon Wiboonchutikula, Ph.D ,Associate professor and

Chairperson of Faculty of Economics, Chulalongkorn University & Professor Salinee. Secretatery

international economics and finance. My striking thanks go to honorable sir Dr. MN.Sirker who

has helped me in all aspect to prepare the report.

I would like to thank lab incharge Ms. Mink . Last but not the least I wish to thank my

friends, William Lloyed ,Nakarin and Athipat, for their very helpful discussions.

Sk. Ashiquer RahmanId#4585974929Chulalongkorn UniversityMasters in International Economics and FinanceBangkok, Thailand


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Table of ContentTitle Page

Letter of Transmittal iiPreface iiiAcknowledgement ivTable Of Content vStatement Of The Problem 1-1Literature Review 1-1Formulation Of General Model 2-3Data Sources &Description 3-4Model Estimation And Hypothesis Testing 5-14Interpretation Of The Results And Conclusions 15-15References 15-15


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(I).StatementoftheProblems

Under the economic conceptual, namely the IS-LM framework, the government might increase

the income by operate the fiscal expansion policy. The same gold also can occur from themonetary sector. The central bank might choose to increase the money supply level in order to

expand the economic growth. However, the policy manipulation might not able to achieve the

target since some of economic reason. Then, this paper tries to predict that how effectiveness ofthe fiscal and monetary.

(II)Reviewsofliteratureandtheoreticalbackground:One of the economic frameworks, which illustrate the relationship of the macroeconomic

variables, is the IS-Lm framework. The IS-LM framework goes beyond the simple Keynesiancross model of national income determination by adding a monetary sector and allowing for the

simultaneous interactions between investment, the interest rate and the demand for money, and

between saving, income and the demand for money. It is therefore an extremely useful and

versatile model, which can be used to discuss the effects of change in exogenous expenditure,

fiscal policy, monetary policy, and so on. The IS curve shows all the combinations of income

and interest rate at which the market for good and services is in equilibrium, in the sense that

expenditure is equal to output. The consumption is assumed to be a function of measured

income. It is positively related to the income.

C = a + by a > 0, 00

The LM curve is the locus of all the combinations of interest rate and real income at which the

money market is in equilibrium that is the demand for money equal supply of money. It is

assumed that the supply of money is fixed exogenous by the government, i.e. M, = M. At the

equilibrium, it can get that;

Md/P = d+mY-iR

Ms= M.

Ms =M

Ms=Md

Then, it might be able to obtain R as a function of Y;

R=Pd-M+m.Y


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(V.2) Model EstimationI apply the two stage least square method in model (1) and model(2) because we can see model (1)and model(2) are ovridentified. So the outputs of these models are show below:

Dependent variable: csMethod : Two stage Least squaresDate: 06/15/02 Time: 12.-02Sample: 1950:1 1985:4Included observations: 144Instrument list: CS(-1 ) (Y(-1)-Y(-2) ) Y(-1) G (MS-MS(-1) ) (R(-1)-R(-2) )

R(-4) Variable Coefficie Std. Error t-Statistic Prob

C -3.622196 4.949340 -0.731854 0.4655

Y 0.027667 0.018173 1.522411 0.1301CS(-1) 0.965346 0.027151 35.55409 0.0000

R-squared 0.999466 Mean dependent var 1411.162

Ad usted R-s uared 0.999458 S. D. de endent var 486.7321S.E. of re ression 11.32836 Sum s uared resid 18094.79F-statistic 131920.0 Durbin-Watson stat 1.628630Prob(F-statistic) 0.000000

Dependent Variable: IMethod: Two-Stage Least SquaresDate: 06/15/02 Time: 12:29Sample: 1950:1 1985:4Included observations: 144Instrument list: CS(-1) (Y(-1)-Y(-2) ) Y(-1) G (MS-MS(-1) ) (R(-1)-R(-2) ) R ( -4 )

Variable Coefficie Std. Error t-Statistic Prob.

C -64.08308 8.167319 -7.846281 0.0000

Y(-1)-Y(-2) 0.178104 0.077128 2.309196 0.0224 Y 0.216422 0.005670 38.16637 0.0000

R4v4) -10.94074 1.225571 -8.927052 0.0000R-squared 0.967537 Mean dependent var 383.8354

Ad usted R-s uared 0.966841 S. D. de endent var 131.0940S. E. of re ression 23.87161 Sum s uared resid 79779.56


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F-statistic 1381.824 Durbin-Watson stat 0.545257Prob(F-statistic) 0.000000

I apply the least squares method in model (3) because model (3) is exactly identified. So the output of

the model (3) is show below:Dependent Variable: R Method: Least SquaresDate: 06/15/02 Time: 13-.30Sample: 1950:1 1985:4Included observations: 144

Variable Coefficie Std. Error t-Statistic Prob.

According the above tables, it may summarize that the result of estimation are;

CS = -3.622196416 + 0.02766714557 Yt + 0.9653459803 CSc_1 ------------------------------------------------(1)t-stat (-0.37) (1.52) (35.55)R2-= 0.99 S.E. = 23.87 DW - 1.63 Durbin h -2.35

I = -64.08308199 + 0.1781044365 (Y,_, - Y, ) + 0.2164223566 Y, - 10.9407366 R,_, (2)t-stat (-7.84) (2.31) (38.16) (-8.93)R2- - 0.97 S.E. = 23.87 DW - 0.55

R = -3.683841135 + 0.003960784 Y, - 0.01292640826(Y, - Y" ) (3)t-stat (-8.95) (23.00) (-249)- 0.09925883596 (MS,-MS,, ) +0.2936927099(R,, - R,-,)t-stat (-3.14) (1.59)RZ = 0.80 S.E. = 1.47 DW = 0.51

C

Y

Y-Y(-1)

MS-MS(-1}

-3.683841

0.003961

-0.012926

-0.099259

0.411369 -8.955067

0.000172 23.00733

0.005194 -2.488564

0.031588 -3.142259

0.0000

0.0000

0.0140

0.0020

R-squared 0.803749 Mean dependent var 5.15343

Adjusted R-squared 0.798101 S. D. dependent var 3.26889S.E. of regression 1.468817 Akaike info criterion 3.64089Sum squared resid 299.8820 Schwarz criterion 3.74401Log likelihood - F-statistic 142.318Durbin-Watson stat 0.513725 Prob(F-statistic) 0.00000


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Yt = CS, + It + (4)

(V.3). The Interpretation of the resultAccording the result from equation, even though the current consumption should depend oil the

income by the theory, however, this case, the consumption is just determined by lag consumption

itself. Since the equation (1) is the autoregressive equation, then, the Durbin h statistic is

constructed. From the h statistic, it implies that there is no autocorrelation problem in this model.

By the way, the investment behavior follows as the theory state. It depends on the income level and

also has a negatively related with the interest rate. For the interest rate determinant, it can be

explained by the current income, the rate of change rate of income, and the rate of change rate of

money supply. However, it does not have any related with its lag value. Moreover, it might able to

see the historical simulation of consumption, investment, interest rate, and income from the

diagram as follow

CSCSSML1

IISML1


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(V.4).Export Forecast:After we got the estimated result, then it might want to test the goodness of fit of model in the

prediction.Hence,

we make the export forecast], by using the date 1986:1to 1988:1.The result is show as:


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According the above graph, the simulation model may able to forecast the movement of the

economic variables. Nevertheless, it seems that the power of the prediction is not quite good. Thus,

we might want to confirm the goodness of the model by calculating for the root mean square error,


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(V.5).Policy Analysis:Supposed that the government increase the exogenous expenditure by 3 percent, while also increase

the money supply for 1 percent. The result show as follows


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(V.6). Interpretation the policy EffectivenessAccording the graph which shown in the section (V.5), it illustrates the effectiveness of the government policy. Inthis case, we let the government increase the government expenditure and also expand the money supply. The result

is consistent with the theoretical background.

We might interpret the result by combining the result in section (V.5) and the theoretical background in

section (V.6) together.

R

R10

R0

R

A

B

Y Y01

LM

C

Y

RIS

Y1

IS

LM1


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The Fiscal Policy

At the beginning period of time, the autarky equilibrium stays at point A, income stay at ''+- , and interest rate at .

Then, the government injects the government expenditure amount 3 percent in to the economy. This might increase

the aggregate demand. The IS curve shift to the right. The economy moves to point B. At that time, the

consumption will increase to Y01(2650). The interest rate rise up from .(11%) to Rfll (12.75%). The investment

will also increase from 770 to 820. This evidence drive the national income from i,(4100) to Yol (4300).

The Monetary Policy

At the same time, the central bank also injects the money supply into the economy. The LM curve will shit to the

right. The economy moves from point B to C. The consumption level still rises up to 2700. However, the interest rate

will drop to 11.5. These events drive the national income up to 4400, eventually.

(VI).Conclusion

This paper tries to study the effectiveness of the government policy, both of fiscal policy and monetary policy. The

paper use the simulation model to capture the effect of the 3 percent increase in the government expenditure, and

the 1 percent increase un the money supply. By the simulation method, we might able to predict the changing

magnitude of the economic variable, such as consumption, interest rate, investment, and the national income. All

of the information is available in the interpretation part (V.6).

(VII).References

1).Gujarati, DamodarN., Basic Econometrics, Mcgrawhill, 2003

2).Pindyck, Robert S., and Daniel L. Rubinfeld,Econometric ModelsAndEconomic Forecasts, Mcgrawhill,

1998

3.).Cobham, David,MacroeconomicAnalysisan intermediate text, Longman, 1998


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APPRENDIX


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a paper on policy effectiveness

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