MA project Economic Data Analysis

http-equiv="Content-Type" content="text/html;1990
charset=utf-8">566.238
I. INTRODUCTION:566.238
This is a study that focuses on the relationship1.1108
that exist between the interest rates that prevail477.138
in an economy and the amount of money1991
demanded in an economy, the intuition is that548.532
when interest rates are high then we expect that581.897
the amount of money demanded in the economy1.0992
will be less, this is because interests rate is the504.133
opportunity cost of holding money and therefore1992
when there are high interest rates then less549.543
money will be demanded.605.295
When interest rates are high the opportunity1.0912
costs of borrowed funds is too high and517.883
therefore less of it is demanded. When interest1993
rates are low then people will demand more561.346
money in an economy. Government will therefore638.4
use interest rates as a tool to stabilise the1.0787
economy in case of inflation caused by excess544.055
demand.1994
Various theories exist to explain the factors that580.092
determine the demand for money, this include the675.164
Keynesian demand for money theory, Milton1.0805
Friedman’s quantity demand for money567.157
theory, Tobin’s liquidity preference theory[4]
and the Fisher’s money theory.The data provided above can be graphically
In this study we will use UK data from the yearillustrated as shown in diagram one below
1984 to the year 1994 to analyse the relationshipDiagram one
that exist between the money supply and theFrom the graph in diagram one the interest rates
interest rates that prevail in the economy, thehave declined over the years.
data will be used to estimate the equation Md = FMoney demanded over the years is indicated
(IR) where Md is the money demanded in angraphically in diagram two below
economy, and IR is the interest rate. ThereforeDiagram two
the model states that money demand is aFrom the graph the money demanded has
function of interest rates.increased over the years.
II. UNDERLYING THEORIES:§ Model specification:
Many theories have come up to explain theOur first assumption is that money supply is
factors that determine demand for money in theequals to the money demanded that is to say
economy; they include the Keynes theory, thethat Md = Ms, our model is specified as Md= F
Milton theory and the Fishers theory of money. All(IR), therefore we expect that the model will
this scholars recognise the effect of changes intake the form of Md = B + IR x where B will the
interest rates on money demanded.a. Keynesautonomous money demanded and x is the
theorymeasure of the effect of interest on money
Keynes argued that money demand in andemanded. We will assume that only interest
economy is determined by three factors, therates will determine the amount of money
precautionally demand for money, liquiditydemanded in the economy, we shall therefore run
preference and the speculative demand forthe regression that will determine the relationship
money. The amount held by firms and individualsbetween the money demanded and interest
depend on the level of income and the institutionalrates.[5]
arrangements of the economy, they will hold§ Estimation of the model:
money for their day to day transactions in orderWe will use the classical estimation model to
to purchase goods and services.estimate the model, the classical regression model
§ Precautionally demand for moneystates that when the model takes the form of
The precautionally demand for money arises fromY= α + β x, then you estimate the
uncertainties of life and unseen events, themodel as follows:
amount held will depend on the level of income,α = Y- β x, and that
the higher the level of income the higher theβ = n ∑x y - ∑ x∑ y
amount held for precautionally purposes, the______________n ∑ x2 - (∑
prevailing interest rates will also determine thex) 2
amount held for precautionally purposes, because
the interest rates are the opportunity costs ofWhere n is the number of observations and
holding money the higher they are the less is thetherefore we estimate our model using the data
amount held.provided, our y will be the money demand Md and
Institutional arrangement will also determine thex will be our interest rates IR, we therefore
amount held in that if an economy providesobtain our products for x and y, and x2 . Our
certain services such free medical care the lessresults are shown in table two.[6]
the amount held by the people for precautionallyTable twoxyxyx2
purposes.YEAR
§ Speculative demand for moneyREAL DOMESTIC EXPEDITURE
This demand for money arises when theNOMINAL DOMESTIC EXPEDITURE
individuals and firms in an economy hold moneyINTEREST RATES
for the purpose of speculation, money isMEASURE OF MONEY HOLDINGS
therefore held as an asset and therefore they will
hold money for the purpose of purchasing other
interest bearing assets. The amount held for1984
speculation purposes depend on the level of450.949
interest rates and the level of income.326.498
§ Liquidity preference1.1069
This demand will arise from the fact that people198.93
and firms will hold money for the purpose of their220.19562
day to day transactions; they will hold money to1.225228
purchase goods and services.[1]b.1985
Friedman’s theory464.316
According to Friedman sees money as just354.291
another way in which wealth can be held, he1.1062
assumes that money is like any other asset. He224.794
argued that the demand of money is determined248.66712
by the total wealth of an individual, the expected1.223678
rate of interest, the ratio of human to non human1986
wealth and the taste and preferences of people in487.33
an economy.388.179
He derived the following model1.0987
Real demand for money = F (W, r, w, T)258.304
Where:283.7986
W is the total wealth of an individual, as W1.207142
increases the demand for money also increases.r1987
is the expected rate of interest, as the rate of513.083
interest rate increases the less is the amount of428.721
money demanded.w is the ratio of human and1.0947
non human wealth, human wealth is less liquid than304.948
any other form of wealth so an increase in the333.82658
liquidity of human wealth will increase the amount1.198368
of money demanded.1988
T is the taste and preferences, institutional553.461
arrangements and the culture of the people in an488.953
economy.[2]1.0936
Therefore the two scholars recognise the358.233
relationship between the rate of interest and the391.76361
amount of money demanded. We therefore now1.195961
establish the relationship between them using the1989
data from the UK economy from the year 1984569.719
to the year 1994. We shall use this data to537.279
estimate the equation Md = F (IR) where Md is1.0958
the money demanded in an economy, and IR is426.322
the interest rate.467.16365
III. MODEL SPECIFICATION AND ESTIMATION:1.200778
§ Data[3]1990
Table one.566.238
Data for the UK from the year 1984 to1994:566.238
amount in million pounds1.1108
YEAR477.138
REAL DOMESTIC EXPEDITURE530.00489
NOMINAL DOMESTIC EXPEDITURE1.233877
INTEREST RATES1991
MEASURE OF MONEY HOLDINGS548.532
1984581.897
450.9491.0992
326.498504.133
1.1069554.14299
198.931.208241
19851992
464.316549.543
354.291605.295
1.10621.0912
224.794517.883
1986565.11393
487.331.190717
388.1791993
1.0987561.346
258.304638.4
19871.0787
513.083544.055
428.721586.87213
1.09471.163594
304.9481994
1988580.092
553.461675.164
488.9531.0805
1.0936567.157
358.233612.81314
19891.16748total
569.71912.0563
537.2794381.897
1.09584794.
426.322