In answering Question 22 in Unit 2, we stated that there is room for improving the St. Louis equation estimates by simply dropping the insignificant lagged variables.

In so doing, we ended up with the following model: Yt =+0 Mt +3 Mt-3 +4 Mt-4 +1 Gt-1 +4 Gt-4 +ut

where Y is the rate of growth in nominal GDP; M is the rate of growth in money supply (the monetary policy variable); and G is the rate of growth in government spending (or the fiscal policy variable).

Now answer the following questions for the above improved St. Louis equation model.

1. Present the OLS SRF estimates.

2. Draw and interpret the pattern of the effect of an expansionary monetary policy on AD.

   Also, draw and interpret the pattern of the effect of an expansionary fiscal policy on AD.

3. Use the LM (Lagrange-Multiplier) test to check whether the St. Louis equation suffers from

   an autocorrelation problem (up to the 4th-order).

4. Use the Ljung-Box test to check whether the St. Louis equation suffers from an

   autocorrelation problem (up to the 4th-oredr and the 8th-order).

5. Use the White test to see if the St. Louis equation suffers from a heteroscedasticity problem.

6. In case there exists a heteroscedasticity problem, use the White procedure to correct it. Are

   the new estimates substantially different from the original estimates? Explain.

7. Does the St. Louis equation suffer from a specification error problem? Is the St. Louis

   equation stable in terms of parameters?

8. What is a high multicollinearity problem? What are the empirical consequences of this

   problem for the OLS estimators? How do you detect and treat this problem.

9. Check whether the St. Louis equation suffers from a high multicollinearity problem.

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10. Is the normality assumption empirically supported?

11. Do the individual and overall test of significance.

12. Is the total effect of an expansionary monetary policy significantly different from zero?

13. Is the total effect of an expansionary fiscal policy significantly different from zero?

14. Is the total effect of an expansionary monetary policy significantly equal to 1? Interpret

    the results.

15. Are you satisfied with the estimated St. Louis equation? Explain.