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Fall 2003 - Ramanathan's Class - Exam 2

# Fall 2003 - Ramanathan's Class - Exam 2 - Econ 120C Fall...

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1 Econ 120C Ramu Ramanathan Fall 2003 Second exam answers I. In an aggregate economy, let M* be the desired stock of money, Y per capita income, and r the interest rate. The long-run equilibrium relationship for the desired stock of money is given by the double log model (where LN stands for natural log) (1) * t LNM = a + b LNY t + g LNr t + u t Because of market frictions, the desired stock of money can be attained only through dynamic adjustments. Consider the following partial adjustment mechanism that determines the actual stock of money ( LNM t ). (2) LNM t = LNM t- 1 + l ( * t LNM - LNM t- 1 ) 0 < l < 1 Ia (8 points). Derive an estimable econometric relation of the form (3) LNM t = 1 b + 2 b LNM t- 1 + 3 b LNY t + 4 b LNr t + u t in which the coefficients of equation (3) are expressed in terms of a , b , g , and l (show your derivation) . Express each i b in terms of a , b , g , and l . LNM

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Fall 2003 - Ramanathan's Class - Exam 2 - Econ 120C Fall...

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