Structural Change by 1973 Oil Crisis

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Examine Quantity Theory of Money

• Structural Change by 1973 Oil Crisis

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• Part A
• Examining the Quantity Theory of Money
• Part B
• Test Whether 1973 Oil Crisis cause a structural
  change

3
About Quantity Theory of Money

• The 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

• The Quantity Theory
• Neo-Keynesian
• Cost push inflation
• Demand pull inflation
• Built-in inflation

5
Methodology

•  Fisher identity or  equation of exchange
• MV PY
• M is the money supply
• V is the velocity of circulation of money
• P is the general price level
• Y 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 (ß0 ).
• Thus, we yield the regression like this
• lnP ß0 ß1lnM ß2 lnY

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Sample

• Country United States
• Period 1959Q1 to 2010Q3
• Data
• M is M2
• P is the GDP Deflator
• Y is the real GDP

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Result

• We run a OLS estimation on the regression
• lnP ß0 ß1lnM ß2 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 US
• It 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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Methodology

• The Chow test is used to do the test.
• Separate the whole period to two sub-periods
• 1959Q1 to 1973Q3
• 1973Q4 to 2010Q3
• Establish the Hypothesis

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• Run OLS on two sub-sample groups separately and
  obtain the RSS1, and RSS2, (RSS1RSS2RSSUR)
• Run OLS on the whole sample (N) and obtain the
• restricted RSSR

• Compute
• F
• If F gt Fc ?, k1, N-2k-2 gt reject H0

(RSSR - RSS1 RSS2)/k1/ (RSS1 RSS2)/N-2k-2
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• RSSR (Whole Period) 0.603807
• RSS1 (1959Q1 to 1973Q3) 0.029737
• RSS2 (1973Q4 to 2010Q3) 0.445407
• By computation
• F 18.14275 , where Fc 3.9491
• Where a0.01

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• Since F 18.14275 , Fc 3.9491
• F gt Fc ?, k1, N-2k-2 gt reject H0
• There is a structural change, Var(?1)?Var(?2)?s2
• 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!