T.C.

EGE UNIVERSITY FACULTY OF ECONOMICS AND ADMINISTRATIVE SCIENCES

APPLIED ECONOMETRICS

FINAL PROJECT

INCOME AND INTEREST RELATIONSHIP WITH MONEY SUPPLY; NORWAY EXAMPLE

ASSISTANT DO.DR. MEHMET KARAUKA

PINAR KELBA

13110000350

ZMR 2016
Abstract
In this paper; I examine the relationship between Money Demand, Interest Rate and Income. So
in this context; for the period between 1985 and 2014 in Norway, the interest rate, and the income
and their impact on the money demand has been discussed. Finding money demand in an
economy is not possible so basic economics equation says that, money demand equals money
supply, money supply used as money demand.

The Model;

Mt=0 + 1Y1t - 2R2t + Ut

for t=1985, 1986, , 2014
In this model; Mt describes money supply in an economy and it is an independent variable. Y is
income and R is the interest rate and these are dependent variables. There is a negative
relationship between money demand and interest rate. Thus 1 and 2 should be positive.
VARIABLES

Years Broad Money Supply Interest Rate Income

M4
1985 16.2 11.87 15753,5527652129

1986 17.7 13.30 18883,265802712

1987 19.4 13.31 22505,8977117052

1988 22.3 11.86 24207,281468963
1989 23.6 9.79 24281,0961405377
1990 25.3 9.64 28242,943738533
1991 28.0 9.96 28596,9330036444
1992 29.6 8.57 30523,9850558974
1993 32.3 5.84 27963,6652188271
1994 33.3 6.40 29315,8419070199
1995 35.1 6.38 34875,1973878148
1996 38.7 5.73 37321,4433901355
1997 39.8 4.85 36628,5174155741
1998 41.8 4.36 34788,7785642698
1999 44.6 4.46 36371,3957875661
2000 49.4 5.18 38146,7153917477
2001 54.1 5.20 38549,5893413937
2002 58.4 5.34 43061,1503812416
2003 61.2 4.01 50111,6544494522
2004 64.1 3.33 57570,2691601943
2005 70.4 2.71 66775,3943971756
2006 78.4 3.04 74114,697150083
2007 91.1 3.73 85128,6575906714
2008 94.6 3.42 96880,5096146393
2009 97.4 3.96 80017,7768095085
2010 100.0 2.49 87646,2700974708
2011 107.9 2.10 100575,117263444
2012 113.8 1.10 101563,702677597
2013 119.2 1.54 102832,258689863
2014 127.1 1.48 97299,636068076
Source!

https://data.oecd.org/interest/long-term-interest-rates-forecast.htm#indicator-chart!
http://data.worldbank.org/indicator/NY.GDP.PCAP.CD!
Properties of Data

Mean and Standard

Deviation
90.000

67.500

45.000

22.500

0
0,00 1,00 2,00 3,00 4,00
Ordinary Least Squares

F- Test
H0: Parameters in the model are insignificant.
H1 Parameters in the model are significant.

P-value (F) 1.01e-21 < 0.01 Reject the null hypothesis.

Parameters in the model are significant.

T- Test
H0: 0=0; 1=0; 2=0
H1: 0 0; 10; 20
P-value for 0 is 0.0387 < 0.05
1 is 8.86e-15 < 0.01
2 is 0.0222 < 0.05 Reject the null hypothesis.

Estimator or coefficient statistically significant.

The R2 is also quite high (0.97) signifying a strong relationship between the income and interest
rate, and the money supply.
In an economy, 1 unit of increase in income, money supply also increase 0.00100814 unit.
When income and interest rate is equal to zero, money supply is 15.1536.
Standard error for 0 is 6.97317, for 1 is 6.61821e-05 and for 2 is 0.562768.
Jarque Bera Normality Test
Frequency distribution for uhat3, obs 1-30
Number of bins =7, mean =3.31587e-15, sd=5.84507

Test for null hypothesis of normal distribution:

Chi-square(2) = 6.196 with p-value 0.04513

H0: Residuals are normally distributed

H1: Residuals are not normally distributed

Jarque-Bera test = 6.196, with p-value 0.04513

Do not reject null hypothesis. Residuals are normally

distributed.
Multicollinearity

H0: 0=0; 1=0; 2=0

H1:00; 1 0; 2 0

Variance Inflation Factors

Minimum possible value = 1.0
Values > 10.0 may indicate a collinearity problem

Interest Rate 3.152

Income 3.152

VIF(j) = 1/(1 - R(j)^2), where R(j) is the multiple correlation

coefficient
between variable j and the other independent variables
Belsley-Kuh-Welsch collinearity diagnostics:

lambda
=eigenvalues of
X'X, largest to
smallest

cond = condition
index
note: variance proportions columns sum to 1.0

Existence of a perfect or exact linear ship among some or all

explanatory variables of a regression model.

3.152 < 10.0 There is no multicollinearity.

Whites Heteroscedasticity Test
H0: There exist heteroscedasticity.
H1: There exist no heteroscedasticity.

White's test for heteroscedasticity

OLS, using observations 1985-2014 (T = 30)
Dependent variable: uhat^2

Unadjusted R-squared = 0.179604

Test statistic: TR^2 = 5.388124

with p-value = P(Chi-square(5) > 5.388124) = 0.370370

Reject null hypothesis. There is heteroscedasticity.
Durbin Watson Test
H0: There exist no first- order autocorrelation.
H1: There exist first order autocorrelation.

Durbin-Watson statistic = 0.965774 p-value =

0.000200791
5% critical values for Durbin-Watson statistic, n = 30, k = 2

dL = 1.2837
dU = 1.5666

There exist positive autocorrelation. Reject H0

Breusch-Godfrey Test
H0: =0 (No autocorrelation)
H1:0 (Autocorrelation)
Breusch-Godfrey test for first-order autocorrelation
OLS, using observations 1985-2014 (T = 30)!
Dependent variable: uhat

Unadjusted R-squared = 0.186947

Test statistic: LMF = 5.978229,
with p-value = P(F(1,26) > 5.97823) = 0.0216

Alternative statistic: TR^2 = 5.608405

with p-value = P(Chi-square(1) > 5.60841) = 0.0179

Ljung-Box Q' = 3.98871

with p-value = P(Chi-square(1) > 3.98871) = 0.0458
P(F(1, 26) > 5.97823) = 0.0215687
Reject null hypothesis. There is autocorrelation.
Ramseys RESET Test
H0: Model is correctly specified.
H1: Model is not correctly specified.

Auxiliary regression for RESET specification test

OLS, using observations 1985-2014 (T = 30)
Dependent variable: BroadMS_M4

Test statistic: F = 0.922257

with p-value = P(F(2,25) > 0.922257) = 0.411
Fcrit > Fcalc. Accept null hypothesis. Model is correctly specified.
Granger Causality Test

H0: 0=0; 1=0; 2=0

H1: 00; 10; 2 0

VECM system, lag order 2

Maximum likelihood estimates, observations 1987-2014 (T = 28)
Cointegration rank = 1

Case 3: Unrestricted constant beta (cointegrating vectors, standard errors in

parentheses)

BroadMS_M4 1.0000
(0.0000)
Income -6.4973e+11
(8.3294e+12)
InterestRate 2.2178e+16
(6.3126e+16)

alpha (adjustment vectors)

BroadMS_M4 8.2982e-19
Income 4.5242e-15
InterestRate -2.8855e-18

Log-likelihood = nan
Determinant of covariance matrix = 44461441
AIC = nan
BIC = nan
HQC = nan
Equation 1: d_BroadMS_M4
Equation 2: d_Income

Equation 3: d_Interest rate

Cross-equation covariance matrix:

determinant = 4.44614e+07
Fcalc < Fcrit Could not reject H0 . Money supply does not cause interest rate.
Conclusion

In this project, I examined the relationship between money supply, interest rate and income. Money
supply is a dependent variable, interest rate and income are independent variable. As I explained
before, there is a negative relationship between money supply and interest rate.
F- tests and T- Tests conclusions, parameters in the model, estimator and coefficient are
significant. So this model is statistically meaningful and there is a relationship between these. In
Jarque- Beras result; residuals are normally distributed. It means that assumption is valid and
model inference (confidence intervals, model predictions) also be valid.
And in multicollinearity test, the result is there is no multicollinearity. So meaning that one can be
linearly predicted from the others with a substantial degree of accuracy.
In Whites Test calculation there is heteroscedasticity obtained. When the standard deviations of
this variable, monitored over a specific amount of time, are non-constant. Variance of money
supply model, is not constant. When we apply Durbin Watson test in this model; we obtained there
exist positive autocorrelation. A positive correlation exists when as one variable decreases, the
other variable also decreases and vice versa. So there is an increase in income, interest rate will
also increase as a same amount. Breusch- Godfrey test says that; there is autocorrelation. This
means, there is a correlation between error terms in this models variables. There is a change in
incomes error term, interest rates error term will also change. In the other hand when we analyze
Ramseys RESET test; model is correctly specified. If the regression equation contains all of the
relevant predictors, including any necessary transformations and interaction terms. That is, there
are no missing, redundant or extraneous predictors in the model. And we examine causality,
Granger Causality test says; money supply does not cause interest rate. This means there is a
change in money supply, interest rate will not effect.