3.19. The relationship between nominal exchange rate and relative prices. From the annual observations from 1980 to 1994, the following regression results were obtained, where Y = exchange rate of the German mark to the U.S. dollar (GM/S) and X = ratio of the U.S. consumer price index to the German consumer price index; that is, X represents the relative prices in the two countries: = 6.682 — 4.318K, se = (1.22)(1.333) 528 a. Interpret this regression. How would you interpret r?? 'b. Does the negative value of X; make economic sense? What is the un- derlying economic theory? c. Suppose we were to redefine X as the ratio of German CPI to the U.S. CPI. Would that change the sign of X? And whv? 3.19 (a) The slope value of 4.318 suggests that over the period 1980- 1994, for every unit increase im the relative price, on average, the (GMS) exchange rate declined by about 4.32 units. That is, the dollar depreciated because it was getting fewer German marks for every dollar exchanged. Literally interpreted, the intercept value of 6.682 means that if the relative price ratio were zero, a dollar woul exchange for 6.682 German marks. Of course, this interpretation is not economically meaningful. (b) The negative value of the slope coefficient makes perfect economic sense because if U.S. prices go up faster than German, prices, domestic consumers will switch to German goods, thus increasing the demand for GM, which will lead to appreciation of the German mark. This is the essence of the theory of purchasing power parity (PPP), or the law of one price. (c) In this case the slope coefficient is expected to be positive, for the higher the German CPI relative to the U.S. CPI, the higher the relative inflation rate in Germany which will lead to appreciation of the U.S. dollar. Again, this is in the spirit of the PPP.5.8. Consider the following regression output": 0.2033 + 0.6560X, (0.0976) (0.1961) r2= 0397 RSS=0.0544 FSS =0.0358 ‘ where Y= labor force participation rate (LFPR) of women in 1972 and X= LFPR of women in 1968. The regression results were obtained from a sample of 19 cities in the United States. b. How do you interpret this regression? Test the hypothesis: Ho: fy = 1 against Hi: A: > 1. Which test do you use? And why? What are the underlying assumptions of the test(s) you ‘Suppose that the LFPR in 1968 was 0.58 (or 58 percent). On the basis of the regression results given above, what is the mean LFPR in 1972? Establish a 95% confidence interval for the mean prediction. How would you test the hypothesis that the error term in the popula- tion regression is normally distribute? Show the necessary calculations. (a) There is. positive association in the LFPR in 1972 and 1968, which is not surprising in view of the fact since WW IT there has been a steady increase in the LFPR of women. (®) Use the one-tail ¢ rest. tw OSS00>1 = 1.7542. For 17 df, the one-tailed ¢ value at @ 5% is 1.740. Since the estimated t value is significant, at this level of significance, we can reject the hypothesis that the truc slope cocfficient is 1 or greater. (©) The mean LEPR is : 0.2033 + 0.6560 (0.58) ~ 0.5838. To ‘establish a 95% confidence interval for this forecast value, use the formula: 0.5838 + 2.11 (se of the mean forecast value), where 2.11 is the 5% critical r value for 17 df. To get the standard error of the forecast value, use Eq, (5.10.2). But note that since the authors do not give the mean value of the LFPR of women in 1968, we cannot compute this standard error (q@) Without the actual data, we will not be able to answer this question because we need the values of the residuals to plot them and obtain the Normal Probability Plot or to compute the value of the Jarque-Bera test.8.14, B14 From a sample of 209 firms, Wooldridge obtained the following regres- sion results": log (Salary) = 4.32 + 0.280 log(sales) + 0.0174 roc + 0.00024 ros se = (0.32) (0.035) (0.0041) (0.00054) R?=0.283 where salary = salary of CEO sales = annual firm sales roe = return on equity in percent ros = return on firm's stock and where figures in the parentheses are the estimated standard errors. ‘a, Interpret the preceding regression taking into account any prior expec tations that you may have about the signs of the various coefficients. b. Which of the coefficients are individually statistically significant at the 5 percent level? ¢. What is the overall significance of the regression? Which test do you use? And why? . Can you interpret the coefficients of roe and ros as elasticity coeffi- cients? Why or why not? (@A priori, salary and cach of the explanatory variables are ‘expected to be positively related, which they are. The partial coefficient of 0.280 means, cereris paribus, the elasticity of CEO. salary is a 0.28 percent. The coefficient 0.0174 means, ceteris paribus, if the rate of raturn on equity goes up by I percentage point 1 percent), then the CEO salary goes up by about 1.07 %. Similarly, ceteris paribus, if return on the firm's stock goes up by I percentage point, the CEO salary goes up by about 0.024%. (b) Under the individual, or separate, null hypothesis that each true population coefficient is zero. you can obtain the ¢ values by simply dividing cach estimated coefficient by its standard error. These f values for the four coefficients shown in the model are, respectively, 13.5, 8, 4.25, and 0.44, Since the sample is large enough, using the two-f rule of thumb, you can see that the first three coefficients areindividually highly statistically significant, whereas the last one is ‘insignificant. (e) To test the overall significance, that is, all the slopes are equal to zero, use the F test given in (8.5.11), which yields: = RMD __ 0285/3 _ a7 99 C—R)Ka—B) (0.717) /205 Under the null hypothesis, this ¥ has the F distribution with 3 and 205 df in the numerator and denominator, respectively. The p value of obtaining such an F value is extremely small, leading to rejection of the null hypothesis, (d) Since the dependent variable is in logarithmic form and the roe and ros are in linear form, the coefficients of these variables give semi elasticities, that is, the growth rate in the dependent variable for an absolute (unit) change in the regressor.8.17. Consider, the following wage-determination equation for the British economy’ for the period 1950-1969: W,= 8582 + 0.304(PF), + 0.004(PF),_1— 2.560U; (1.129) (0.080) (0.072) (0.658) R'=0873 0 df=15 where W wages and salaries per employee PF = prices of final output at factor cost U unemployment in Great Britain as a percentage of the total number of employees of Great Britain t=time (The figures in the parentheses are the estimated standard errors.) a. Interpret the preceding equation. b. Are the estimated coefficients individually significant? ¢. What is the rationale for the introduction of (PF).-1? d. Should the variable (PF);_; be dropped from the model? Why? ‘e. How would you compute the elasticity of wages and salaries per em- ployee with respect to the unemployment rate U? 8.18. A variation of the wage-determination equation given in exercise 8.17 is as follows': W,= 1.073 + 5.288V;— 0.116X, + 0.054M, + 0.046M,1 (0.797) (0.812) (0.111) (0.022) (0.019) R=0.934 df=14 where W =Wwages and salaries per employee unfilled job vacancies in Great Britain as a percentage of the total number of employees in Great Britain gross domestic product per person employed port prices port prices in the previous (or lagged) vear (The estimated standard errors are given in the parentheses.) a. Interpret the preceding equation. b. Which of the estimated coefficients are individually statistically significant? ¢. What is the rationale for the introduction of the X variable? A priori, is the sign of X expected to be negative? d. What is the purpose of introducing both M, and M,_1 in the model? e. Which of the variables may be dropped from the model? Why? £. Test the overall significance of the observed regression.