AGEC 317 Homework # 5 Spring 2004 In Keynesian theory of liquidity preference the transactions, precautionary, and speculative motives for holding money lead to a function where the demand for money depends on income and the interest rate. Suppose the demand for money is a linear function given by m t 1 2 y t 3i t u t where mt represents money in the form of currency and demand deposits (commonly called M1), yt is gross national product, and it is the interest rate on 6-month U.S. Treasury bills. Observations on these variables for the U.S. economy for the period 1960 - 1983 are in the file moneydata.xls (located on the class web page). 1. Estimate the money demand equation using OLS. Interpret your estimated equation; be sure to discuss individual coefficients, as well as overall goodnessof-fit. 2. Are the signs of the estimated parameters consistent with your prior expectations? Be sure to discuss, what signs would you expect for β2 and β3 and why. 3. Predict money demanded for a gross national product of $1000 billion and an interest rate of 12%. Predict money demanded for a gross national product of $600 billion and an interest rate of 6%. 4. The elasticity of demand for money with respect to income is defined as m t y t . y t m t Use your estimated equation for mt. Find the elasticity of demand for money at the sample means. Find the elasticity of demand for money at the point given in question 3. Explain the differences, if any, in elasticity values. 5. Repeat question 4 for the elasticity of demand for money with respect to the interest rate.