[Solved] To examine the quantity theory of money, Brumm (2005) (“Money Growth, Output Growth, and Inflation: A Reexamination of the Modern Quantity

Background

To examine the quantity theory of money, Brumm (2005) (“Money Growth, Output Growth, and Inflation: A Reexamination of the Modern Quantity Theory’s Linchpin Prediction,” Southern Economic Journal, 71(3), 661–667] specifies the inflation equation inflat = B1 + Bzmoney + Bzoutput + u where inflat is the growth rate of the general price level, money is the growth rate of the money supply, and output is the growth rate of national output. Economic theory suggests that B2 = 1 and B3 = -1. The dataset brumm.dta consists of 1995 data on 76 countries. Research tasks 1. It is argued that output may be endogenous. Four instrumental variables are proposed, initial – initial level of real GDP, school = a measure of the population’s educational attainment, inv = average investment share of GDP, and poprate average population growth rate.

(a) Give an intuitive explanation as to why output can be endogenous (3 marks) (b) Explain why the proposed IVs can be valid. (6 marks, i.e., 2 marks for understanding of valid IVs and 1 mark for convincing story for each IV)

Call: Im_robust(formula inflat ~ money + output, se_type = “stata”) Standard error type: HC1 Coefficients: Estimate Std. Error t value Pr(>[t]) CI Lower CI Upper DF (Intercept) -0.2342 0.61962 -0.378 7.065e-01 -1.4691 1.001 73 money 1.0331 0.02369 43.603 5.085e-54 0.9859 1.080 73 output -1.6620 0.17591 -9.448 2.706e-14 -2.0126 -1.311 73 Multiple R-squared: 0.9948 Adjusted R-squared: 0.9947 F-statistic: 956.8 on 2 and 73 DF, p-value: < 2.2e-16

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Answer to To examine the quantity theory of money, Brumm (2005) (“Money Growth, Output Growth, and Inflation: A Reexamination of the Modern Quantity….