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(III) Formulation of General Model:

According the IS-LM framework as illustrate above, one might able to

setup the model as Follow;CS t = 0 + 1 Y t + 2 CS t- 1 + 1t----------------------------------------------------(1)

It = 3 + 4 (Y t-1 Y t-1 ) + 5 Y t + 6R t-1 + 2t ------------------------------------------------(2)

R t = 7 + 8 Y t + 9 (Y t Y t-1 ) + 10 ( MS t -MS t-1 )+ 11 (R t-1 R t-2 ) + 3t ------(3 )

Yt = CS t + I t + G t ------------------------------------------------------------------------------------------------------------- (4)Where

CS = Real Aggregate Personal ConsumptionI = Real Gross Domestic Investment

Y = Real GNP (Net of Export and Import) RealGovernment SpendingG = Real Money Stock, Narrowly Defined (M1)MS = Treasury BillsR = Interest Rate on 3-Month Treasury Bills.

(IV)Data sources and Description

The equations are estimated using quarterly time-series data from 1950thought the end of 1985 (Pindyck and Rubinfeld, 1998). The variablesdescription is shown as follows.

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(V). Model Estimation and Hypothesis Testing

(V.1). Identification Test

Since the problems of simultaneous equation is the identificationproblem. It need to know the type of the identification in order to choosethe appropriate estimation method, otherwise, the estimator might facewith the problems of bias and inconsistent.

The way to check the identification problem might classify into twocategories. The first is The Order Condition, and the second is The Rank

Condition. The first one is the necessary condition, but not sufficient. Thesecond one is sufficient and also necessary. However, for the largesimultaneous equation model, apply the rank condition is a formidable task.While Harvey notes that the order condition is usually sufficient to ensureidentifiability. Hence, this paper will check the identification under the ordercondition.

The model consists of four endogenous variables (CS, I, Y, R), and sevenpredetermine

variables (CS, , t1',_, - Y t _, ) , Y,_, , G t , (MS t - MS ,_, ) , ( R t -t - R t-z

By the order condition which state that K-k >_ m-1

WhereK is number predetermined variables in the model including theinterceptK is number of predeterniined variables in a given equationm is number of endogenous variables in a given equation

The result is;

Equation no. K-k m-1 Identified Estimation

(1) 6 1 Overidentified 2SLS

(2) 5 1 Overidentified 2SLS

(3) ? ? Exactly identified OLSHowever, the interest rate appears as an explanatory variable only in theinvestment equation, then, it need not worry about inconsistency in the OLS

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estimation of the coefficient of the interest rate equation (Recursive model).

In short, since two of three equations are over identified (equation (1) and (2)),then, the first two equation will be estimated under two-stage least squares(2SLS). However, the third equation will be estimated under OLS method.

(V.2) Model Estimation

I apply the two stage least square method in model (1) andmodel(2) because we can see model (1) and model(2) areovridentified. So the outputs of these models are show below:

Dependent variable: cs

Method : Two stage Least squaresDate: 06/15/02 Time: 12. -02Sample: 1950:1 1985:4Included observations: 144Instrument list: CS(-1 ) (Y(-1)-Y(-2) ) Y(-1) G (MS-MS(-1) ) (R(-1)-R(-2) )

R -4Variable Coeffici Std. Error t- Prob

C - 4.949340 - 0.4655 Y 0.027667 0.018173 1.5224 0.1301

CS(-1) 0.965346 0.027151 35.554 0.0000R-squared 0.999466Mean dependent var 1411.1Ad usted R- 0.999458S. D. de endent var 486.73S.E. of re ression 11.328 Sum s uared resid 18094.F-statistic 131920 Durbin-Watson stat 1.6286Prob(F-statistic) 0.000000

Dependent Variable: IMethod: Two-Stage Least SquaresDate: 06/15/02 Time: 12:29Sample: 1950:1 1985:4Included observations: 144Instrument list: CS(-1) (Y(-1)-Y(-2) ) Y(-1) G (MS-MS(-1) ) (R(-1)-R(-2) )

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are;

CS = -3.622196416 + 0.02766714557 Y t + 0.9653459803 CSc_1

------------------------------------------------(1)

t-stat (-0.37) (1.52) (35.55)R 2- = 0.99 S.E. = 23.87 DW - 1.63 Durbin h -2.35

I = -64.08308199 + 0.1781044365 (Y,_, - Y, ) + 0.2164223566 Y, -

10.9407366 R,_ ., (2)

t-stat (-7.84) (2.31) (38.16) (-8.93)

R 2- - 0.97 S.E. = 23.87 DW - 0.55

R = -3.683841135 + 0.003960784 Y, - 0.01292640826(Y, - Y" ) (3)

t-stat (-8.95) (23.00) (-249)

- 0.09925883596 (MS,-MS,, )

+0.2936927099(R,, - R,-,)

t-stat (-3.14) (1.59)

R Z = 0.80 S.E. = 1.47 DW = 0.51

Y t = CS, + I t + (4)

(V.3). The Interpretation of the result

According the result from equation, even though the current consumptionshould depend oil the income by the theory, however, this case, theconsumption is just determined by lag consumption itself. Since the equation

(1) is the autoregressive equation, then, the Durbin h statistic is constructed.From the h statistic, it implies that there is no autocorrelation problem in thismodel. By the way, the investment behavior follows as the theory state. Itdepends on the income level and also has a negatively related with theinterest rate. For the interest rate determinant, it can be explained by thecurrent income, the rate of change rate of income, and the rate of change rateof money supply. However, it does not have any related with its lag value.

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Moreover, it might able to see the historical simulation of consumption,investment, interest rate, and income from the diagram as follow

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-------CS -------- CSSML1

-------I -------- ISML1


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From the above information, most of the indicators show that the model isquite fit to actual data. Especially, the Theil inequality coefficient is quite low.It approaches to zero. Then, overall, the model is good for forecast.(V.5).Policy Analysis:

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(V.6). Interpretation the policy EffectivenessAccording the graph which shown in the section (V.5), it illustrates the effectiveness of the government policy. Inthis case, we let the government increase the government expenditure and also expand the money supply. The resultis consistent with the theoretical background.

We might interpret the result by combining the result in section (V.5) and the theoretical background in

section (V.6) together.

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R

R10

R0

R1

A

B

Y0 Y01

LM0

C

Y

RIS0

Y1

IS1

LM1


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The Fiscal Policy

At the beginning period of time, the autarky equilibrium stays at point A, income stay at ''+- , and interest rate at .

Then, the government injects the government expenditure amount 3 percent in to the economy. This mightincrease the aggregate demand. The IS curve shift to the right. The economy moves to point B. At that time, the

consumption will increase to Y 01(2650). The interest rate rise up from .(11%) to R fll (12.75%). The investment

will also increase from 770 to 820. This evidence drive the national income from i,(4100) to Y ol (4300).

The Monetary Policy

At the same time, the central bank also injects the money supply into the economy. The LM curve will shit to the

right. The economy moves from point B to C. The consumption level still rises up to 2700. However, the interest rate

will drop to 11.5. These events drive the national income up to 4400, eventually.

(VI). Conclusion

This paper tries to study the effectiveness of the government policy, both of fiscal policy and monetary policy. The

paper use the simulation model to capture the effect of the 3 percent increase in the government expenditure, and

the 1 percent increase un the money supply. By the simulation method, we might able to predict the changing

magnitude of the economic variable, such as consumption, interest rate, investment, and the national income. All

of the information is available in the interpretation part (V.6).

(VII). References

1).Gujarati, Damodar N., Basic Econometrics, Mcgrawhill, 2003

2).Pindyck, Robert S., and Daniel L. Rubinfeld, Econometric Models And Economic Forecasts, Mcgrawhill,

19983.).Cobham, David, Macroeconomic Analysis an intermediate text, Longman, 1998

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APPRENDIX

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policy effectiveness 3

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