Assignment Task
Task
Problem 1: money, Growth, and Inflation
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 = ?1 + ?2money + ?3output + 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 ?2 = 1 and
?3 = ?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)
2. Using the four IVs, obtain TSLS estimates of the inflation equation (4 marks), and test the
economic theory using the IV estimates (4 marks).
3. Determine whether the IVs are strong or not (3 marks) and test if they are exogeneous (3 marks).
4. Present a short research note (less than a half page) of your findings. You are allowed to use your
previous findings here again or to estimate again the model using a different set of IVs (7 marks).
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