2

1.      [100 points] You collect unadjusted, quarterly data on nominal wages, unemployment, and prices in the United States from 1940 through 2011 from the United States Bureau of Labor and Statistics.  Wages are the median wage in the United States in each quarter, the unemployment rate is reported for each quarter, and price is an index based on the Consumer Price Index in each quarter.    

A.     [8 points] Can we use the data as is to run a reliable regression of the unemployment rate on wages?  Why or why not, and is there any way we could transform the data into something more reliable?

B.     [12 points] You next decide to further examine the relationship between wages and prices over this time period.  You run a regression of ln(wage) on price and lagged price and obtain the following results (standard errors in parentheses):

ln(wage) _it = 0.576 + 0.041*price _it – 0.0224*price _it-1 + 0.016*price _it-2 – 0.029*price _it-3 + µ_it

                            (0.013)  (0.01)                 (0.008)                   (0.019)                  (0.01)

N = 284, R² = 0.958

What is the temporary and permanent impact of an increase in prices on wages based on these results?  How would we test if the permanent impact of a price change is statistically significant?