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MEL15701
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r3t = the (ex post) real interest rate as measured by the return on three-month T-bill rates:
r3t = i3t - inft, where the inflation rate is based on the Consumer Price Index.
The explanatory variables in this model are endogenous so then the model requires
instrumental variables. The valid instrumental variables for the model are lagged values of gc,
gy, and r3.
The expected value for coefficients 1 and 2are described as follows:
1is expected to have positive sign because as income increases, individuals may prefer to
increase their consumption. This is because people tend to maximize their utility subject to
the budget constraint. As income increases, so does the budget constraint and individuals
preferences. Meanwhile, 2is expected to have negative sign because the value of real interest
rate, as measured by the return of three-month T-bill rates minus the inflation rate, alters
individuals decision to consume. If the real interest rate is high, people will tend to save
rather than to consume because saving (especially in bank) is more profitable. In addition, the
hypothesis for the pure form of PIH where the value of 1 =2= 0 as exampled in Wooldridge
will be re-tested with the new set of data.
2. OLS Estimation of the Model
The following table shows the comparison of descriptive data statistic between original
data and extended data.
Table 1. Descriptive Statistic of the Data
1959-1995
Variable Obs Mean
Std.
Dev.
1959-2012
Min
Max
Variable Obs
Mean
Std.
Dev.
Min
Max
gc
36 .0204738 .0126375
.0402088
.0091066
gc
gy
36 .0217153 .0182399
.061985
.0169735
gy
53 .0252422 .0429182
r3
37 1.423784 2.064335
r3
gc_1
35 .0206894 .0127547
.0402088
.0091066
gc_1
gy_1
35 .0216098 .0184951
.061985
.0169735
gy_1
52 .0255734 .0432685
-3.26
5.43
.303214
.03719
5.43
.303214
.03719
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r3_1
36 1.388056 2.081984
-3.26
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5.43
r3_1
5.4
The Following figures show the comparison of OLS Estimation with different
time frame.
Figure 1. 2SLS Regression with 1959-1995 Data
Instrumental variables (2SLS) regression
Source
SS
df
MS
Model
Residual
.003759532
.001786069
2
32
.001879766
.000055815
Total
.005545602
34
.000163106
gc
Coef.
r3
gy
_cons
-.0002698
.5826035
.0081396
Instrumented:
Instruments:
Std. Err.
.0007639
.0747338
.002054
t
-0.35
7.80
3.96
Number of obs
F(2, 32)
Prob > F
R-squared
Adj R-squared
Root MSE
P>|t|
0.726
0.000
0.000
=
=
=
=
=
=
35
33.68
0.0000
0.6779
0.6578
.00747
.0012861
.7348312
.0123236
r3
gy L.gc L.gy L.r3
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Source
df
MS
Model
Residual
.109200546
.007392314
2
49
.054600273
.000150864
Total
.11659286
51
.002286135
gc
Coef.
r3
gy
_cons
-.0014683
1.084533
-.0017636
Instrumented:
Instruments:
Std. Err.
.0011152
.041438
.0021641
-1.32
26.17
-0.81
Number of obs
F(2, 49)
Prob > F
R-squared
Adj R-squared
Root MSE
P>|t|
0.194
0.000
0.419
=
=
=
=
=
=
52
362.45
0.0000
0.9366
0.9340
.01228
.0007728
1.167806
.0025853
r3
gy L.gc L.gy L.r3
3. Interpretation of Results
Following the above OLS estimation, the equation can be written as follows:
gct
0.00813
0.00205
gct
-0.00176
0.583
gyt
0.075
+
0.00216
1.084
0.041
0.00027 r3t
(1)
0.00076
gyt
0.00014 r3t
(2)
0.00111
Looking at equation (2) with new set of data, as expected, the expected value of 1is
positive and the expected value of 2is negative. This sign is corresponding with what
expected before. However, compared with the original set of data in equation (1), the
coefficient of 1increases while the coefficient of 2decreases.
a. Statistical Significance
With the new set of data, the following section will convey the significance testing of the
variables. At 1% critical value for a two-tailed test with 49df is 2.660, therefore the null
hypothesis H0: 1= 0 is rejected in favor of alternative hypothesis H1: 1 0. For the latter
4
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coefficient, at 1% critical value for a one-tailed test with 49 df, is 2.390, the null
hypothesis H0: 2= 0 is rejected in favor of alternative hypothesis H1 = 2< 0.
b. Goodness of fit
The equation (2) gives bigger R2than that of equation (1) where the R2value from
equation (2) is 93.66%. This means that as the data extended, both the explanatory
variables gyand r3 are able to explain the 93.66% variability of gc.
c. Linear Restriction
For this section, the null hypothesis is stated as follows:
H0:1=2, where the alternative is
H1:1 0or/and 2 0
The null hypothesis implies that none of the explanatory variables have any impact on the
dependent variable. The test result by using stata is:
( 1)
- r3 + gy = 0
F(
1,
49) =
Prob > F =
676.10
0.0000
Since the value of F-statistic is zero, we reject the null hypothesis at any percentage
significance level. Therefore, both of the variables have impact on dependent variable gc.
4. Model Specification
a. Heteroskedasticity Testing
The null hypothesis for heteroskedasticity testing is no heteroskedasticity. The result of
the test is:
IV heteroskedasticity test(s) using levels of IVs only
Ho: Disturbance is homoskedastic
Pagan-Hall general test statistic : 4.636 Chi-sq(4) P-value = 0.3267
Looking at the result, we fail to reject the null hypothesis, therefore, no heteroskedasticity
present.
b. Autocorrelation Testing
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The null hypothesis for autocorrelation testing is no autocorrelation. The result of the test
is:
Cumby-Huizinga test with H0: errors nonautocorrelated at order 1
Test statistic: 5.6504315
Under H0, Chi-sq(1) with p-value: .01745108
The result implies that no autocorrelation present, therefore, we fail to reject the null
hypothesis.
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IV (2SLS) estimation
Total (centered) SS
Total (uncentered) SS
Residual SS
=
=
=
gc
Coef.
r3
gy
_cons
-.0014683
1.084533
-.0017636
Number of obs
F( 2,
49)
Prob > F
Centered R2
Uncentered R2
Root MSE
.1165928599
.147710145
.0073923142
Std. Err.
.0010825
.0402249
.0021007
z
-1.36
26.96
-0.84
=
=
=
=
=
=
52
362.45
0.0000
0.9366
0.9500
.01192
P>|z|
0.175
0.000
0.401
-.00359
1.005694
-.005881
.0006535
1.163373
.0023537
42.489
0.0000
19.801
13.91
9.08
6.46
5.39
22.30
12.83
9.54
7.80
relative
relative
relative
relative
size
size
size
size
bias
bias
bias
bias
5.558
0.0621
Instrumented:
r3
Included instruments: gy
Excluded instruments: L.gc L.gy L.r3
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5. Summary
This project means to test the permanent income hypothesis as it was conducted by
Campbell and Mankiw. Their research concluded that the pure form of the PIH is strongly
rejected because the coefficient on gy is economically large, in Wooldridge (2012), p.571.
After the data are extended until 2012, the result is the same with what Campbell and
Mankiw found:the coefficient for gy becomes larger than the original data.
In term of goodness of fit, the latter estimation gives better result than that of the former.
This is reflected in the value of R2. Therefore, the latter estimation implies that the
explanatory variables in the model are able to explain 93.66% variability of dependent
variable gc.
The model is regressed by using two stage least square method because it has endogenous
variable. The instruments validity testing presents a good conclusion where the instrumental
variables used have reasonable statistic results with an exception on the Sargan statistic, at
10% significance level the null hypothesis is rejected.
Finally, the model has two explanatory variables and also has endogenous variable.
Though the value of R2 increases as the data extended, I think the reliability of this model is
not sufficient. This is because there are some issues related with the nature of time series
estimation. As Campbell and Mankiw stated on their research, they did not distinguish the
consumption expenditure on durables, just nondurables and services. Another problem is that
the data measurement since consumption and income are tallied as quarterly averages rather
than at points in time.
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References:
Campbell, J. Y., &Mankiw, N. G. (1990). Permanent Income, current income, and consumption.
Journal of Business & Economic Statistics, 8 (3), 265-279. Retrieved February 3rd, 2016,
from http://scholar.harvard.edu/files/mankiw/files/permanent_income.pdf
Mankiw, N. Gregory. (2015). Macroeconomics (9thed). New York: Worth Publishers
US Government Publishing Office. (2016). Economic report of the president: 2012. Retrieved
February 7th, 2016, from
https://www.gpo.gov/fdsys/browse/collection.action?collectionCode=ERP&browsePath=
2013&isCollapsed=false&leafLevelBrowse=false&isDocumentResults=true&ycord=0
Wooldridge, Jeffery. M. (2012). Introductory Econometrics: A Modern Approach (5thed). USA:
South-Western-Cengage Learning.