Download - Examine Quantity Theory of Money
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Structural Change by 1973 Oil Crisis
Examine Quantity Theory of Money
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Part AExamining the Quantity Theory of Money
Part BTest Whether 1973 Oil Crisis cause a
structural change
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About Quantity Theory of MoneyThe Quantity Theory was first developed by
Irving Fisher in the inter-war years as is a basic
theoretical explanation for the link between
money and the general price level.
Roughly speaking, the Quantity Theory try to
explain the cause of inflation.
The Theory is argue that the inflation is caused
by the growth of Money Supply
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Cause of inflation
1) The Quantity Theory
2) Neo-Keynesian
Cost push inflation
Demand pull inflation
Built-in inflation
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Methodology Fisher identity or equation of exchange
MV = PY
①M is the money supply
②V is the velocity of circulation of money
③P is the general price level
④Y is the real value of national output (i.e.
real GDP)
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Fisher identity or equation of
exchange
MV = PY
lnM + lnV = lnP + lnY
To test the cause of growth of price level
(inflation), we yield
lnP = lnM + lnV - lnY
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To simplify our examining, we hold the
growth rate of the velocity of circulation of
money (V) being constant (β0 ).
Thus, we yield the regression like this:
lnP = β0 + β1lnM + β2 lnY
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SampleCountry: United States
Period: 1959Q1 to 2010Q3
Data:
①M is M2
②P is the GDP Deflator
③Y is the real GDP
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ResultWe run a OLS estimation on the regression:
lnP = β0 + β1lnM + β2 lnY The result is:
lnP = 2.918171 + 0.893281 lnM - 0.650627 lnY
R-squared = 0.992265 RSS = 0.603807
We can conclude that the Quantity Theory of Money significantly explain the cause of inflation
(0.028347 )(0.33306 ) (0.061715 )
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Test Whether 1973 Oil Crisis cause a structural change
1973 Oil Crisis lead the GDP growth of US
decreased by 4.7%
It shows that 1973 Oil Crisis is a serious
economic shock for USIt is worth to test that whether 1973 Oil
Crisis bring a structural change (in term of the effect of the growth of money supply and output to the inflation.)
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MethodologyThe Chow test is used to do the test.
Separate the whole period to two sub-
periods:
①1959Q1 to 1973Q3
②1973Q4 to 2010Q3
Establish the Hypothesis:H0: No structural changeNo structural change, Var(1)=Var(2) =σ2H1 : Yes, there is a structural change, Var(1)≠Var(2)≠σ2
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Compute:
FF** =
If FF** > F > Fc c , k+1, N-2k-2 ==> reject H0
[(RSSRSSRR - RSSRSS11 RSSRSS22)/k+1]/k+1]/ (RSS (RSS11 +RSSRSS22)/N-N-2k-22k-2
• Run OLS on two sub-sample groups
separately and obtain the RSSRSS11, and RSSRSS22, ,
((RSSRSS11++RSSRSS22=RSS=RSSURUR))
Run OLS on the whole sample (N) and obtain
the
restricted RSSRSSRR
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RSSRSSRR (Whole Period)= 0.603807 RSSRSS1 1 (1959Q1 to 1973Q3) = 0.029737
RSSRSS2 2 (1973Q4 to 2010Q3)= 0.445407
By computation:F*= 18.14275 , where F Fc c ==3.9491Where α=0.01
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Since F*= 18.14275 , FFc c ==3.9491
FF** > F > Fc c , k+1, N-2k-2 ==> reject H0
There is a structural change, Var(1)≠Var(2)≠σ2
We can conclude that the effects of the growth of
money supply and output to the inflation have
had a structural change after 1973 oil crisis!