Structural Change by 1973 Oil Crisis

Examine Quantity Theory of Money

Part AExamining the Quantity Theory of Money

Part BTest Whether 1973 Oil Crisis cause a

structural change

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

Cause of inflation

1) The Quantity Theory

2) Neo-Keynesian

Cost push inflation

Demand pull inflation

Built-in inflation

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)

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

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

SampleCountry: United States

Period: 1959Q1 to 2010Q3

Data:

①M is M2

②P is the GDP Deflator

③Y is the real GDP

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 )

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.)

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

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

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

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!