In a Study of the Long-Run and Short-Run Demands for Money

Essay

In a study of the long-run and short-run demands for money, Chow estimated the following demand equation (standard errors in parentheses) for the United States from 1947:1 through 1965:4: $$\begin{array} { l } \hat { \mathrm { M } } _ { \mathrm { t } } = 0.14 + 1.05 \mathrm { Y } _ { \mathrm { t } } ^ { * } - 0.01 \mathrm { Y } _ { \mathrm { t } } - 0.75 \mathrm { R } _ { \mathrm { t } } \\\text { (0.15) (0.10) (0.05) } \\\overline { \mathrm { R } } ^ { 2 } = 0.996 \quad \mathrm { DW } = 0.88 \quad \mathrm {~N} = 76 \text { (quarterly) } \\\end{array}$$ where: M_t = the log of the money stock in quarter t
$\mathrm { Y } _ { \mathrm { t } } ^ { * }$ =the log of permanent income (a moving average of previous quarters' current
income) in quarter t
Y_t =the log of current income in quarter t
r_T = the log of the rate of interest in quarter t
(a) Hypothesize signs and test the appropriate null hypotheses at the 5% level of significance.
(b) What econometric problems seem likely to be in this equation?
(c) In particular, are there are any problems related to the coefficient of Y? If so, are these problems more likely to have been caused by multicollinearity, serial correlation, or heteroskedasticity?
(d) What suggestions would you have for another estimation of this equation? Why?