# MSc Economics International Macroeconomics Week 7, Question 1

Management

Oct 28, 2013 (4 years and 8 months ago)

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MSc Economics

International Macroeconomics

Week 7, Question 1

Question 1 (A)

The Structural VAR is ordered as follows:

Inflation

GDP

Fed Funds

When structured this way, shocks to FFR (e.g. an increase in rates)
will not affect inflation and GDP in the current period

VAR Model
-

Substituted Coefficients:

===============================

LNUSCPI = 1.691827373*LNUSCPI(
-
1)
-

0.6980632138*LNUSCPI(
-
2)
-

0.003641672283*LNUSGDP(
-
1) +
0.01276524149*LNUSGDP(
-
2) + 0.001517339296*FFR(
-
1)
-

0.001126735969*FFR(
-
2)
-

0.05037386818

LNUSGDP =
-

0.1302752908*LNUSCPI(
-
1) + 0.1432198375*LNUSCPI(
-
2) + 1.06372222*LNUSGDP(
-
1)
-

0.08775376507*LNUSGDP(
-
2) + 0.0008235577637*FFR(
-
1)
-

0.001708974253*FFR(
-
2) + 0.1650409067

FFR = 32.85437185*LNUSCPI(
-
1)
-

32.84682393*LNUSCPI(
-
2) + 27.65474255*LNUSGDP(
-
1)
-

27.76446871*LNUSGDP(
-
2) +
0.764388546*FFR(
-
1) + 0.1249981824*FFR(
-
2) + 1.033321276

Question 1 (A)

Eviews output

Vector Autoregression Estimates

Date: 02/24/08 Time: 14:02

Included observ ations: 176 af ter adjusting endpoints

Standard errors in ( ) & t
-
statistics in [ ]

LNUSCPI

LNUSGDP

FFR

LNUSCPI(
-
1)

1.691827

-
0.130275

32.85437

(0.05675)

(0.11709)

(21.3061)

[ 29.8097]

[
-
1.11260]

[ 1.54202]

LNUSCPI(
-
2)

-
0.698063

0.143220

-
32.84682

(0.05567)

(0.11485)

(20.8986)

[
-
12.5396]

[ 1.24700]

[
-
1.57173]

LNUSGDP(
-
1)

-
0.003642

1.063722

27.65474

(0.03544)

(0.07311)

(13.3033)

[
-
0.10277]

[ 14.5495]

[ 2.07878]

LNUSGDP(
-
2)

0.012765

-
0.087754

-
27.76447

(0.03490)

(0.07200)

(13.1016)

[ 0.36577]

[
-
1.21877]

[
-
2.11917]

FFR(
-
1)

0.001517

0.000824

0.764389

(0.00021)

(0.00044)

(0.07945)

[ 7.16939]

[ 1.88612]

[ 9.62075]

FFR(
-
2)

-
0.001127

-
0.001709

0.124998

(0.00022)

(0.00045)

(0.08261)

[
-
5.12029]

[
-
3.76429]

[ 1.51311]

C

-
0.050374

0.165041

1.033321

(0.02281)

(0.04706)

(8.56313)

[
-
2.20840]

[ 3.50703]

[ 0.12067]

R
-
squared

0.999971

0.999682

0.850505

-
squared

0.999970

0.999670

0.845198

Sum sq. resids

0.002092

0.008904

294.8265

S.E. equation

0.003518

0.007259

1.320809

F
-
statistic

960591.6

88481.39

160.2458

Log likelihood

748.1982

620.7356

-
295.1326

Akaike AIC

-
8.422707

-
6.974268

3.433325

Schwarz SC

-
8.296608

-
6.848169

3.559424

Mean dependent

4.410224

8.636031

6.271875

S.D. dependent

0.638510

0.399863

3.357000

Determinant Residual Cov ariance

9.72E
-
10

1076.944

Akaike Inf ormation Criteria

-
11.99936

Schwarz Criteria

-
11.62106

Question 1 (B)

VAR with Commodity Prices included

LNUSCPI

LNUSGDP

FFR

LNCOMPRICE

LNUSCPI(
-
1)

1.481869

-
0.368529

-
33.09176

1.400836

(0.06637)

(0.14446)

(25.2400)

(1.02855)

[ 22.3291]

[
-
2.55113]

[
-
1.31108]

[ 1.36195]

LNUSCPI(
-
2)

-
0.500667

0.367972

29.69308

-
1.395681

(0.06408)

(0.13949)

(24.3723)

(0.99319)

[
-
7.81275]

[ 2.63797]

[ 1.21832]

[
-
1.40526]

LNUSGDP(
-
1)

-
0.027740

1.033963

18.35919

0.538966

(0.03343)

(0.07276)

(12.7129)

(0.51806)

[
-
0.82987]

[ 14.2106]

[ 1.44414]

[ 1.04036]

LNUSGDP(
-
2)

0.044238

-
0.050074

-
16.47289

-
0.536243

(0.03311)

(0.07208)

(12.5943)

(0.51323)

[ 1.33590]

[
-
0.69468]

[
-
1.30796]

[
-
1.04484]

FFR(
-
1)

0.001277

0.000546

0.685222

-
0.004429

(0.00020)

(0.00044)

(0.07700)

(0.00314)

[ 6.30684]

[ 1.23805]

[ 8.89911]

[
-
1.41145]

FFR(
-
2)

-
0.000973

-
0.001498

0.199358

0.000892

(0.00021)

(0.00046)

(0.08025)

(0.00327)

[
-
4.61008]

[
-
3.26140]

[ 2.48436]

[ 0.27264]

LNCOMPRICE(
-
1)

0.011456

0.016885

6.377814

1.322609

(0.00489)

(0.01065)

(1.86141)

(0.07585)

[ 2.34069]

[ 1.58496]

[ 3.42633]

[ 17.4363]

LNCOMPRICE(
-
2)

-
0.003180

-
0.007970

-
4.119064

-
0.334379

(0.00512)

(0.01114)

(1.94623)

(0.07931)

[
-
0.62133]

[
-
0.71549]

[
-
2.11643]

[
-
4.21608]

C

-
0.090975

0.121318

-
10.03786

0.013596

(0.02288)

(0.04979)

(8.70009)

(0.35453)

[
-
3.97695]

[ 2.43642]

[
-
1.15377]

[ 0.03835]

Question 1 (B)
-

Conclusions

Adding the commodity price to the VAR has a significant impact on CPI in relation
to the previous estimate. The profile now looks more reasonable, i.e. inflation falls
in response to tighter monetary policy.

This could be due to commodities weighting in the CPI index. Tighter monetary
policy seems to have a negative relationship with commodity prices. Thus, this
should have a downward influence on inflation.

Question 1 (C1)

FFR Impact on the exchange rate

The structural VAR is ordered as follows:

1.
USCPI

2.
USGDP

3.
FED FUNDS

4.
COMMODITY PRICES

5.
EXCHANGE RATE

6.

7.

8.
UK RPIX

9.
UKGDP

10.
UKTBILL

VAR Model
-

Substituted Coef f icients:

===============================

LNUSCPI = 1.348871695*LNUSCPI(
-
1)
-

0.3914013529*LNUSCPI(
-
2)
-

0.01230689248*LNUSGDP(
-
1) + 0.03849480559*LNUSGDP(
-
2) + 0.0014422
62678*FFR(
-
1)
-

0.0009047567*FFR(
-
2) + 0.0145611322*LNCOMPRICE(
-
1)
-

0.01091170826*LNCOMPRICE(
-
2) + 0.008063635792*S(
-
1)
-

0.01352451854*S(
-
-
1)
-

0.04767811486*UK
-
2)
-

1.917725356e
-
-
1) +
1.119850673e
-
-
2) + 0.0408517177*LUKRPIX(
-
1)
-

0.02492080664*LUKRPIX(
-
2) + 0.01139903386*LUKGDP(
-
1)
-

0.01162403355
*LUKGDP(
-
2) + 0.0005675377704*UKTBILL(
-
1)
-

0.0003086253088*UKTBILL(
-
2)
-

0.1131801331

LNUSGDP =
-

0.3223208462*LNUSCPI(
-
1) + 0.2799333182*LNUSCPI(
-
2) + 0.9138208219*LNUSGDP(
-
1)
-

0.01060493461*LNUSGDP(
-
2) + 0.0006
943965013*FFR(
-
1)
-

0.001629258657*FFR(
-
2) +
0.00920700888*LNCOMPRICE(
-
1)
-

0.006072719048*LNCOMPRICE(
-
2) + 0.03635421322*S(
-
1)
-

0.02063380306*S(
-
2) + 0.07040940128*UKTERMS
-
1)
-

-
2) + 2.268259061e
-
-
1) + 1.349286279e
-
-
2) + 0.07703936536*LUKRPIX(
-
1)
-

0.04201289819*LUKRPIX(
-
2) + 0.1254662759*LUKGDP
(
-
1)
-

0.02241975695*LUKGDP(
-
2) + 0.0001583793567*UKTBILL(
-
1)
-

0.0003705526771*UKTBILL(
-
2)
-

0.3689253727

FFR =
-

49.28779901*LNUSCPI(
-
1) + 42.27191504*LNUSCPI(
-
2) + 21.51514706*LNUSGDP(
-
1)
-

7.143248623*LNUSGDP(
-
2) + 0.5935480029*FF
R(
-
1) + 0.2122752746*FFR(
-
2) + 7.506042879*LNCOMPRICE(
-
1)
-

3.315245984*LNCOMPRICE(
-
2)
-

3.2645823*S(
-
1) + 2.666568094*S(
-
-
-
-
1)
-

-
2)
-

2.213159049*LUKRPIX(
-
1) + 2.104193204*LUKRPIX(
-
2)
-

7.183925024*LUKGDP(
-
1)
-

4.906323214*LUKGDP
(
-
2)
-

0.08650880122*UKTBILL(
-
1) + 0.1381741296*UKTBILL(
-
2) +
36.44809884

LNCOMPRICE = 2.302401252*LNUSCPI(
-
1)
-

2.702905244*LNUSCPI(
-
2)
-

0.3599097683*LNUSGDP(
-
1)
-

0.4498151646*LNUSGDP(
-
2)
-

0.0053372
22801*FFR(
-
1) + 0.0006130417532*FFR(
-
2) +
1.190432274*LNCOMPRICE(
-
1)
-

0.28895531*LNCOMPRICE(
-
2) + 0.06967526184*S(
-
1) + 0.01772405939*S(
-
2)
-

(
-
-
2)
-

1.74585278e
-
-
1) + 7.619151668e
-
-
2)
-

0.4080043159*LUKRPIX(
-
1) + 0.7449591802*LUKRPIX(
-
2) + 1.258300487*LUKGDP(
-
1
)
-

0.1374127435*LUKGDP(
-
2) + 0.008517353541*UKTBILL(
-
1)
-

0.005213726313*UKTBILL(
-
2)
-

5.789238534

S =
-

0.8805616073*LNUSCPI(
-
1) + 0.8490363426*LNUSCPI(
-
2) + 0.2866862984*LNUSGDP(
-
1)
-

0.09311824769*LNUSGDP(
-
2) + 0.0012299852
98*FFR(
-
1) + 0.002010354773*FFR(
-
2)
-

0.009192297949*LNCOMPRICE(
-
1)
+ 0.01931786396*LNCOMPRICE(
-
2) + 1.070997688*S(
-
1)
-

0.2070173218*S(
-
2)
-

-
1) + 0.0872721631*UKTERMSO
-
2)
-

2.62558194e
-
-
1) + 5.186676249e
-
-
2) + 0.09407586933*LUKRPIX(
-
1)
-

0.06217734767*LUKRPIX(
-
2)
-

0.4501603266*LUKGDP(
-
1) + 0.152699043*LUKGDP(
-
2)
-

0
.008258439619*UKTBILL(
-
1) + 0.005320028504*UKTBILL(
-
2) + 1.968079035

-
1)
-

0.4820788842*LNUSCPI(
-
2)
-

0.02413136436*LNUSGDP(
-
1)
-

0.01883139133*LNUSGDP(
-
2)
-

0.
000234321112*FFR(
-
1)
-

5.873553586e
-
05*FFR(
-
2)
-

0.07125190849*LNCOMPRICE(
-
1) + 0.05630918763*LNCOMPRICE(
-
2)
-

0.008452373739*S(
-
1) + 0.002266932784*S(
-
2) + 1.145431441*UKTERMSO
-
1)
-

-
2)
-

2.527291722e
-
-
1) + 7.661851871e
-
-
2) + 0.07357808381*LUKRPIX(
-
1)
-

0.03687923882*LUKRPIX(
-
2) + 0.133460291*LUKGDP(
-
1)
-

0.1108583171*LUKGDP(
-
2)
-

0.001872877381*UKTBILL(
-
1) +
0.001277201053*UKTBILL(
-
2) + 0.1197593384

-
1)
-

51308.73031*LNUSCPI(
-
2)
-

709.2652343*LNUSGDP(
-
1) + 5850.551034*LNUSGDP(
-
2)
-

88.32899176
*FFR(
-
1)
-

96.89951042*FFR(
-
2)
-

499.0719449*LNCOMPRICE(
-
1) +
1471.422221*LNCOMPRICE(
-
2) + 5180.760846*S(
-
1)
-

1950.307469*S(
-
2)
-

-
-
-
1) +
-
2)
-

4709.953999*LUKRPIX(
-
1) + 968.0130649*LUKRPIX(
-
2)
-

11472.4754*LUKGDP(
-
1) + 2375.11123*LUKGDP(
-
2)
+ 42.94953206*UKTBILL(
-
1) + 50.02042575*UKTBILL(
-
2) + 54449.3538

LUKRPIX = 0.8882041486*LNUSCPI(
-
1)
-

0.8335419115*LNUSCPI(
-
2)
-

0.06551536712*LNUSGDP(
-
1)
-

0.04770422206*LNUSGDP(
-
2)
-

0.000944
4956945*FFR(
-
1)
-

3.219783348e
-
05*FFR(
-
2) +
0.0276571887*LNCOMPRICE(
-
1)
-

0.02046480705*LNCOMPRICE(
-
2) + 0.1172803059*S(
-
1)
-

0.1080359058*S(
-
E(
-
1)
-

-
2) + 1.03920604e
-
-
1) + 3.911071052e
-
-
2) + 0.8795076656*LUKRPIX(
-
1) + 0.06753557911*LUKRPIX(
-
2) + 0.1103149307*LUKGDP(
-
1) + 0.06856251634*LUKGDP(
-
2) + 0.001397865159*UKTBILL(
-
1) +
0.000776500158*UKTBILL(
-
2)
-

1.240796257

LUKGDP =
-

0.2114868525*LNUSCPI(
-
1) + 0.1963936611*LNUSCPI(
-
2) + 0.1243537608*LNUSGDP(
-
1)
-

0.01756761823*LNUSGDP(
-
2)
-

0.00040
38710547*FFR(
-
1) + 3.426935758e
-
05*FFR(
-
2) +
0.01413443408*LNCOMPRICE(
-
1)
-

0.01135773256*LNCOMPRICE(
-
2) + 0.008915688338*S(
-
1) + 0.006685063127*S(
-
2)
-

0.07088501263*UKTERM
-
-
2)
-

2.24750405e
-
-
1) + 1.988081379e
-
-
2) + 0.0244808365*LUKRPIX(
-
1)
-

0.01960288989*LUKRPIX(
-
2) + 0.7203637267*LUKGDP(
-
1) + 0.1350266946*LUKGDP(
-
2) + 0.0005122786587*UKTBILL(
-
1)
-

0.001478094629*UKTBILL(
-
2) + 0.8659486053

UKTBILL =
-

28.32088553*LNUSCPI(
-
1) + 23.99767059*LNUSCPI(
-
2)
-

5.759981667*LNUSGDP(
-
1) + 9.145599609*LNUSGDP(
-
2) + 0.119461375
8*FFR(
-
1) + 0.0007021241202*FFR(
-
2) + 3.264854237*LNCOMPRICE(
-
1)
-

1.394208828*LNCOMPRICE(
-
2) + 1.849983103*S(
-
1)
-

0.7951007456*S(
-
-
1)
-

(
-
2)
-

-
1) + 6.02111225e
-
-
2) + 7.629819067*LUKRPIX(
-
1)
-

6.488062373*LUKRPIX(
-
2)
-

3.560326873*LUKGDP(
-
1) + 0.3851952355*LUKGDP(
-
2) + 1.045
223239*UKTBILL(
-
1)
-

0.2539929088*UKTBILL(
-
2) + 16.00963562

Question 1 VAR Output

Question 1 (C1)

FFR Impact on the exchange rate

Exchange rate is defined as £ to \$. Therefore s↑ implies sterling weakening
(dollar strengthening)

A foreign monetary contraction causes the exchange rate to rise (equation (15) in
the lecture notes), so the IRF here seems intuitive.

Question 1 (C2)

FFR impact on the UK External Sector

The terms of trade defined as price of domestically produced goods minus
imported goods, sees a deterioration, with a full recovery taking some time. This
would be consistent with the FX move in the previous question.

Net trade also deteriorates as foreign imports become more expensive, again this
is consistent with the move on FX in the previous question

Question 1 (C3)

FFR impact on the UK output

For UK output, the IRF of a positive shock to FFR is initially positive and then
negative.

Expenditure switching, defined as switching to home produced goods as foreign
goods become more expensive, does not seem to occur here. If this were the
case, we would expect to see UK output increase as consumption of home goods
rises.

Question 1 (D)

is there evidence of LCP?

The results of sections C(1
-
3) suggest the data does support the theory of local
currency pricing.

The response of the exchange rate, from a shock to the FFR is positive. The
exchange rates impact on other variables is how we determine if LCP is present.

The evidence on UK net trade which saw a decrease when the exchange rate
increased would support the idea the idea that LCP is present. This is because
net trade fell. Imports did not fall as they became more expensive, and exports did
not increase as they became cheaper.

The evidence from the impact of FFR on UK output would also support LCP. If
LCP was not present, then output would increase as the exchange rate increased.
i.e. there would be evidence of expenditure switching.