Empirical Testing of Quantity Theory of Money in India

8/7/2019 Empirical Testing of Quantity Theory of Money in India

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EMPIRICAL TESTING OFQUANTITY THEORY OF

MONEY IN INDIA

- ROHIT WALIMBE

- PROF. LAKSHMI KUMAR

International Conference on Quantitative Methods in Money BankingFinance and insurance IBS Hyderabad -19 March 2010


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INTRODUCTION Background and origin of QTM

Concept of the Quantity Theory of Money

(QTM)

MV=PY

M - Quantity of Money (M3- Broad Money )

V - Velocity of Money

P - Aggregate Price Level (GDP deflator)

Y - Real GDP


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Consistent and precise relation between the Mand Y

Is it valid for India in the Long Run ?? Letscheck

Short Run not considered


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- Hypothesis tested :1. Money stock growth contributes positively to

inflation

2. Real GDP growth contributes negatively toInflation.

Other factors contributing to the inflation and

the role of interest rate in explaining inflation


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QTM AS A REGRESSIONMODEL

M V= PY

As inflation is % change in price level,

%change in M + %change in V = %change in P

+ %change in Y


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0123456

78

-

-

1954-55

1956-57

-

-

1962-63

-

-

1968-69

1970-71

-

-

1976-77

-

-

1982-83

-

-

1988-89

1990-91

-

-

1996-97

-

-

2002-03

2004-05

-

-

VELOCITY=GDP CURRENT PRICE/NARROW MONEY

VELOCITY=GDP CURRENT PRICE/NARROW

MONEY

Linear (VELOCITY=GDP CURRENT

PRICE/NARROW MONEY)

Velocity assumed to be constant

%change in P =%change in M%change in Y

i.e. A=BC + u

A is inflation, B is money supply growth and C is real GDP

growth, u is the disturbance term.


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Thus, the unrestricted QTM becomes,

A=o+ 1B+2C+ Assumptions made for which is a disturbance

are,

1. It is random variable with mean or expected value of zero i.e.

E() = 0,

2. Values of are independent

3. The error is a normally distributed random variable


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The hypotheses to be tested are as follows

o =0 , 1 = 1 , 2 = -1

i.e. as money growth increases, and GDP

growth reduces, inflation reacts one to one


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DATA & ANALYSIS OF RESULTS

-0.1

-0.05

0

0.05

0.1

0.15

0.2

0.25

0.3

0 10 20 30 40 50 60

Inflation

REAL GDP GROWTH

CHANGE IN BROAD MONEY SUPPLY

Linear (Inflation)

Linear (REAL GDP GROWTH)

Linear (CHANGE IN BROAD MONEY SUPPLY)

CORRELATION

1Change in Broad Money supply and

Inflation. (B) 0.297

2Inflation and Real GDP Growth (C) -0.332

WEAK BUT

POSITIVE

MODERATE BUT

NEGATIVE


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Regression Statistics

Multiple R 0.4557

R Square 0.2076

Adjusted R Square 0.1724

Standard Error 0.0363

Observations 48

ANOVA

df SS MS FSignificance

F

Regression 2 0.016 0.008 5.895 0.005

Residual 45 0.059 0.001

Total 47 0.075

Coefficients StandardError

t Stat P-value Lower 95% Upper95%

Lower95.0%

Upper95.0%

INTERCEPT 0.05253 0.02060 2.54988 0.01425 0.01104 0.09402 0.01104 0.09402

REAL GDP GROWTH (2) -0.43684 0.16803 -2.59978 0.01257 -0.77527 -0.09841 -0.77527 -0.09841

CHANGE IN BROAD MONEY

SUPPLY (1)0.28127 0.11968 2.35023 0.02321 0.04023 0.52231 0.04023 0.52231


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Monetary policy

What about interest rate

-0.1

-0.05

0

0.05

0.1

0.15

0.2

0.25

0.3

-

1963-64

-

1969-70

-

-

1978-79

-

-

1987-88

-

1993-94

1996-97

-

2002-03

-

Inflation

REAL GDP GROWTH

CHANGE IN BROAD MONEYSUPPLY

Poly. (Inflation)

Poly. (REAL GDP GROWTH)

Poly. (CHANGE IN BROAD MONEY

SUPPLY)

Trend of Inflation, Real GDP Growth and Change in Broad Money Supply


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INTEREST RATE

-5

0

5

10

15

20

25

Y

1972

Y

1974

Y

1975

Y

1977

Y

1980

Y

1982

Y

1983

Y

1985

Y

1988

Y

1991

Y

1993

Y

1996

Y

1999

Y

2001

Y

2004

Y

2007

INFLATION

INTEREST RATE

Poly. (INFLATION)

Poly. ( INTEREST RATE)

Correlation between call/notice interest rate andinflation in India gives a coefficient of +0.351

LONG RUN TREND BETWEEN INTEREST RATE AND INFLATION


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CONCLUSION QTM is not supported by regression model

Positive moderate response of interest rate to

inflation


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Positive correlation of 0.257 between interest

rate and money supply growth

Though interest rate is responding to inflation

this does not get translated into an expansion

or contraction of money supply


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FUTURE WORK Study of lag effect

Study of Taylors Rule in Indian context.


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!!! THANK YOU !!!

ANY QUESTIONS??

Empirical Testing of Quantity Theory of Money in India

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