Economics 421Homework 5
Due July 1
1) Propose a method of estimating the following distributed lag model:
Be sure to explain any assumptions which you make and describe the advantages or disadvantages of your approach. Note that K may, but need not, be infinity.
2) Suppose you have the following model of the demand for money, Mt as a function of income It and the expected interest rate rt:
Mt = % + %1It + %2rt + µ
Following the adaptive expectations model, expectations are formed in the following way:
rt - rt-1 = %(rt - rt-1).
Find the equation to be estimated and discuss any problems there might be in applying ordinary least squares.
3) Suppose you are given the three equation model:
where Y's are endogenous variables and X's are predetermined or exogenous variables. Determine which, if any, of these equations satisfies the necessary order condition for identification. Which, if any, are just identified and which are over identified?
4) Using the data set for homework 5 on my homepage, estimate the model Y = a + b1X1 + b2X2 + µ. Now suppose that you suspect that X1 and Y are simultaneously determined, or that X1 is correlated with µ. X3 is a variable which you believe is highly correlated with X1 but not correlated with µ. Use the two stage least squares command from ET to estimaate the parameters of the true model. Also explain how you would use an instrumental variable technique to do the estimation in two steps. Compare your results from the uncorrected and the 2sls models to the relationship I constructed:
Y=150 + 3X1 + 2X2.
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