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1)INTRODUCTION This paper investigates the relationship between Gross Domestic Product (GDP), Investments and Inflation for United State ( US ) from year 1980-2007. The relationship between GDP, investment and inflation is a popular topic and it was make us interest to do research with it. As we know the GDP is depend to investment and inflation. In the other words that we can say is investment and inflation will affect there countries develop so to make sure our divination is correct or not so we choose this topic as our research topic. Investment measured variables related to the cost of investment or the demand for goods. By enhancing the efficient allocation of investment, the productivity of investment will increase. In reducing the cost of new investment and higher expected returns thereby will be more business investment. Investment positively affects economic growth. When a company or industry with strong demand or a company awash in cash flow would invest more, thereby investment will increase, GDP will increase and economic will shows a positive growth. Beside that, we also examine the relationship between GDP and inflation. Through the result that we test with E-view, we know the relationship between GDP and inflation is negative that coefficient is -0.525627; this mean rising in inflation rate will decrease the GDP rate. It is because during inflation period, all price raise it was make our cost living also raise, so to less burden consumer less their spending so it was make Consumer Price Index (CPI) fall, decreasing in CPI make GDP fall together it is because quantity output supply exceed quantity output demand during inflation period.

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2)LITERATURE REVIEW The literature review covers the various research studies on the link between economic growth and four variables, which is investment and inflation. We examine the relationship between economic growth and the two variables during year 1980 to 2007 in United States. In general, we know Inflation will impair GDP so it mean Inflation and GDP growth have a negative relationship. When inflation rate rise, GDP rate also will increase together. Below is the opinion of few researchers like as Barro (1995) based on the fiscal policy his had report inflation and GDP have a significantly negative relationship if the average of inflation is over 10%. In the other hand, based on analysis of cross-sections regression, Levine and Renelt (1992) and Clark (1997) claim that the negative correlation is independent of inflation rate, his statement verified by Bruno and Easterly (1998) and Bullard and Keating (1995). They show that this negative relationship just determined in ad hoc fashion and Hansen (1996) look at nominal US GDP say that growth is presented in single time series context. But in the research paper that done by Ronald J. York (2007), his say that inflation not cause by increasing in price of goods, but it affect by monetary supply, that mean when the money supply grow faster than the economy then it will make inflation have and vice versa and in his research paper also have wrote not all the inflation will portends a recession economy, but most do. In the research by Michelle L. Barnes (2001) his claim that during the inflation, GDP growth also will rise, because during inflation government will use fiscal policy to increase GDP. As we know that investment and GDP growth has a positive relationship. According to Madden and Savage (1998), investment and economic growth is shows a

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positive relationship and it is limited to lower income economies. Rller and Waverman (2002) statement that in economies, the correlation of investment and economic growth is higher. Besides that, he also statement that when the casual relationships hold jointly, the effect of one relation feeds back onto the other. As point by Chirinko (1993:1906) that investment no affects much to price variables and unimportant related to quantity variables. This means that the relationship between GDP and investment is weak. In the study of De Gregorio & Guidotti (1995), Levine & Zarvos (1998), they used the average per capita income or investment or productivity growth rate over some period to measure GDP growth and a set of control variables. It proved that there is a positive relationship between GDP growth and efficiency of investment.

3)DATA AND METHODLOGY The data in this study is obtained from Federal Reserve Bank of St. Louis where search from internet. The data we gained is from year 1980 to 2007. We are using the yearly data. Thus, the observation that we gained is 28 period. To test this equation, we are using Ordinary Least Square method (OLS). We use 3 variables to support this equation. The 2 independent variables are included inflation and investment. We choose the Growth Domestic Product (GDP) as dependent variable. The result that comes out from the OLS is as below:

t GDP t = 0 1 INFLATION t + 2 INVESTMENT t +

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From the result, it shows that the inflation and unemployment has negative relationship with GDP. When the inflation and unemployment increase in the US, the US GDP will decrease and vice versa. Beside, the investment and trade balance shows positive relationship with GDP. When investment and trade balance increase in the US, the US GDP will increase and vice versa. After test by using OLS, we will test the data by using the T- test. T-test is to determine whether there is sufficient evidence to infer that, in this multiple regression model, independent and dependent variables are linearly related. In the T-test, we are using two tails to determine the i coefficients. It is because we gain the negative
i

coefficients in the equation. To get the critical t, we choose

calculatedt

equal to 0.05 (5%).

Reject H0 if

> critical value. Otherwise, we do not reject or accept H0.

Beside the T-test, we also will test with F-test. F- test use to test whether the independent variables have the overall significance. If computed F > critical F value, Ho will be rejected. Otherwise, we do not reject or accept Ho. Furthermore, Ramseys RESET Test uses to test whether the estimated model is correctly specified or misspecified. Before compute the F, we need to estimate the new equation by using OLS. The new equation is an unrestricted model. The formula to compute the F is:

( R 2 UR R 2 R ) / m F= (1 R 2 UR ) /( n k 1)
where m =number of restriction k = number of independent variables in the new equation 4

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If computed F value > critical F m , n k 1 value, then the null hypothesis of no misspecification will be reject. Otherwise, we do not reject or accept the Ho. In addition to that, to test the heteroscedasticity for the model, we will conduct the White test. White test uses to check whether the error term is heteroscedastic. When the variance of the error variable 2

is not constant, then there is heteroscedastic problem

occurred. To run this test, we need to run the auxiliary regression as follows:

e 2 i = 0 + 1 X 1i + 2 X 2i + 2 X 2 3i + 4 X 2 2i + 5 X 1i X 2i + t
and then obtain the R 2 . If n R 2 > X 2 df , we will reject the Ho. In conclusion, the heteroscedasticity is present in the regression model. Otherwise, we do not reject or accept the Ho. In conclusion, there is free from heteroscedasticity problem in the regression model. Apart from that, we will detect autocorrelation for the regression model with BreuschGodfrey (BG) Test. i. Breusch- Godfrey (BG) Test

Breusch- Godfrey (BG) Test uses to test the higher order autocorrelation. Even the OLS model has lagged values, we still can test the autocorrelation by using this test. To make the conclusion, if (n-p) R 2 exceeds

2 p

, we can reject the null

hypothesis of no autocorrelation. Otherwise, we do not reject or accept the Ho.

4)TESTS AND RESULTS The multiple regression model we use is as follows: 5

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Y t = 0 + 1 X 1 t + 2 X 2 t + ... + t From the data we gained, we use the OLS method to gain the equation as follows: GDP t = -12.1737 0.4289X t +0.8574Y t SE t = (3.9638) = (-3.0712) (0.1039) (-4.1299) (0.2083) (4.117)

R 2 = 0.5058 Where X = inflation

n = 28 (year 1980 to 2007)

Y = investment T test Firstly, we test the relationship between inflation and GDP. Step 1 : Define the H0 and HA H0 : = 0 (the inflation has no significance impact on the GDP) HA : 0 (the inflation has significance impact on the GDP) Step 2 : Decision Rule Choose = 0.05 . The degree of freedom is 25 (n-k-1 = 28 2 1 = 25). Critical t = t 0.05 / 2 = t 0.025 = 2.06 Reject Ho if |calculated t|> 2.06. otherwise, do not reject H0. Step 3 : Compute test-statistic t=

SE ( )

t=

0.4289 0 = -4.1299 0.1039

Step 4 : Decision 6

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Since |calculated t|= |-4.1299| > critical t = 2.06, thus, we are reject the HO. Step 5 : Conclusion There is sufficient evidence to indicate the inflation has significance impact on the GDP at 5% significance level. Secondly, we test the relationship between investment and GDP. Step 1 : Define the H0 and HA H0 : = 0 (the investment has no significance impact on the GDP) HA : 0 (the investment has significance impact on the GDP) Step 2 : Decision Rule Choose = 0.05 . The degree of freedom is 25 (n-k-1 = 28 2 1 = 25). Critical t = t 0.05 / 2 = t 0.025 = 2.06 Reject Ho if |calculated t|> 2.06. otherwise, do not reject H0. Step 3 : Compute test-statistic t=

SE ( )

t=

0.8574 0 = 4.117 0.2083

Step 4 : Decision Since |calculated t|= |4.117| > critical t = 2.06, thus, we are reject the HO. Step 5 : Conclusion There is sufficient evidence to indicate the investment has significance impact on the GDP at 5% significance level. 7

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F Test Step 1 : Define the Ho and HA Ho : 1 = 2 = 0 HA : At least one is not zero Step 2 : Decision rule Choose = 0.05 . The degree of freedom = 25 ( n k 1= 28 2 1 = 25) The 5% critical F-value for k and degree of freedom is F k , n k 1 =F 2 , 25 = 3.39 Thus, if computed F > critical F-value, we reject Ho. Otherwise, do not reject H0. Step 3 : Compute test-statistic
R2 / k F= (1 R 2 ) /( n k 1)

F=

0.5058 / 2 = 12.7919 (1 0.5058)( 28 2 1)

Step 4 : Decision Since computed F = 12.7919 > 3.39, thus, we reject Ho at 5% significance level. Step 5 : Conclusion Since H0 is rejected at 5% significance level, we have enough statistical evidence to infer that all the slope coefficients are statistically significance simultaneously. The independent variables in the model have significance effect on the dependent variable. Ramseys RESET Test Step 1 : Define the Ho and HA Ho : The estimated model is correctly specified HA : The estimated model is misspecfied 8

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Step 2 : Estimate the restricted model and unrestricted model Restricted model: GDP t = -12.1737 0.4289X t +0.8574Y t + t n = 28 Unrestricted model:
2 GDPt = -25.7964 0.8828Xt + 1.7897Yt 0.5718GDP t 0.0777GDP 3 t t +

R 2 = 0.5058

n = 28 Step 3 : Decision Rule

R 2 = 0.5197

The degree of freedom = 23 ( n k 1= 28 4 1 = 23) The 5% critical value for k and degree of freedom is F ,m,n k 1 =F 0.05 , 2 , 23 =3.42 Thus, if computed test statistic > critical F , m , n k 1 , we reject Ho. Otherwise, do not reject H0. Step 3: Compute test statistic F=
(0.5197 0.5058) / 2 = 0.33385 (1 0.5197) /( 28 4 1)

Step 4: Decision Since the F=0.33385 < critical Step 5: Conclusion We have enough statistically evidence to infer that the estimated model is correctly specified at 5% significance level with 2 added explanatory variables. Thus, no misspecification is detected in the model. Heteroscedasticity We generate Whites general heteroscedasticity test in testing the heteroscedasticity. 9

F ,m,n k 1

= 3.42, then do not reject

H0 .

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Step 1 : Estimate regression GDP t = -12.1737 0.4289X t +0.8574Y t t = (-3.0712) (-4.1299) (4.117)

R 2 = 0.5058

n = 28 (year 1980 to 2007)

Step 2 : Run the auxiliary regression

2 2 e t = -2.4217 +5.1598X 0.09495X - 0.1787XY 0.4967Y+ 0.02454Y
2

Step 3 : Compute test statistic n R 2 = 28 (0.1648) = 4.6144 Step 4 : Define Ho and HA. H 0 : 1 = 2 = 3 = 4 = 5 = 0 (no heteroscedasticity problem) H A : at least one slope coefficient is not zero (has heteroscedasticity problem Step 5 : Decision
2 2 We choose at 5% significance level. The critical value, X 5 =11.07. Thus, n R 2 < X 5

where the computed value 4.6144 < critical value 11.07. Therefore, we do not reject the Ho where the null of homoscedasticity error is does not rejected. Step 6 : Conclusion We have enough evidence to infer that the heteroscedasticity problem does not present in the model. Autocorrelation We generate Breusch-Godfrey (BG) test in testing the higher order autocorrelation. Step 1 : Estimate regression GDP t = -12.1737 0.4289X t +0.8574Y t

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1 - 0.1997 t 2 e t = 0.8821 0.00596X 0.04361Y + 0.11002 t

R 2 = 0.04519 Step 2 : Compute test statistic (n p) R 2 = (28 2) (0.04519) = 1.1748 Step 3 : Define Ho and HA. H 0 : 1 = 2 = 3 = 4 = 0 ( there is no autocorrelation) H A : Otherwise (there is autocorrelation of order 5) Step 4: Decision
2 We use = 5%. The critical value X 2 = 5.99147. Since (n p) R 2 = 1.1748 < critical

2 value X 2 = 5.99147, then we do not reject H 0 .

Step 5: Conclusion We can conclude that we do not have enough evidence to show that there is autoregression of order 2 in the model at 5% significance level.

5)CONCLUSION After test the equation, we have gained some results from it. From the T-test, we can know that the inflation and investment have significance impact on the US GDP. It is because from the T-test, the both Ho is rejected. Beside, through F test, it also prove that the independent variables ( inflation and investment ) have joint significance effect on the dependent variable (GDP). Through the Ramseys RESET test, the result is given that there is correctly specified in the estimated model. In other word, there do not exist the error term in the model. 11

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From the Breusch-Godfrey (BG) Test, where the test is detecting the high order autocorrelation, shows that there is no autocorrelation exist in the model. From the White test where to test the heteroscedasticity, we also infer that the model is existing the homoscedastic error.

6)POLICY SUGGESTION The interest rate has significant effect on planned investment. Government should decrease the interest rate, when interest rate fall, cash in hand will increase, planned investment will rise. Contractionary fiscal policy can overcome inflation. In Contractionary fiscal policy, decrease in government spending or increase in taxes leads to cash in hand decrease, this will decrease spending. Thus, demand on goods will decrease and inflation will overcome.

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APPENDIX TABLE 1
Dependent Variable: GDP Method: Least Squares Date: 10/06/08 Time: 18:06 Sample: 1980 2007 Included observations: 28 Variable Coefficient C -12.17370 INFLATION -0.428925 INVESTEMENT 0.857382 R-squared 0.505771 Adjusted R-squared 0.466233 S.E. of regression 1.301964 Sum squared resid 42.37774 Log likelihood -45.53214 Durbin-Watson stat 1.818737

Std. Error t-Statistic 3.963798 -3.071220 0.103859 -4.129887 0.208254 4.117000 Mean dependent var S.D. dependent var Akaike info criterion Schwarz criterion F-statistic Prob(F-statistic)

Prob. 0.0051 0.0004 0.0004 2.930286 1.782063 3.466582 3.609318 12.79193 0.000149

TABLE 2
White Heteroskedasticity Test: F-statistic 0.868199 Obs*R-squared 4.614398 Test Equation: Dependent Variable: RESID^2 Method: Least Squares Date: 10/06/08 Time: 19:24 Sample: 1980 2007 Included observations: 28 Variable Coefficient C -2.421744 INFLATION 5.159777 INFLATION^2 -0.094946 INFLATION*INVEST -0.178682 EMENT INVESTEMENT -0.496675 INVESTEMENT^2 0.024540 R-squared 0.164800 Adjusted R-squared -0.025018 S.E. of regression 2.817673 Sum squared resid 174.6641 Log likelihood -65.35952 Durbin-Watson stat 1.921565 Probability Probability 0.518026 0.464725

Std. Error 107.3703 5.891916 0.073220 0.308158

t-Statistic -0.022555 0.875738 -1.296713 -0.579839

Prob. 0.9822 0.3906 0.2082 0.5679 0.9651 0.9348 1.513491 2.783074 5.097109 5.382581 0.868199 0.518026

11.21843 -0.044273 0.296733 0.082701 Mean dependent var S.D. dependent var Akaike info criterion Schwarz criterion F-statistic Prob(F-statistic)

TABLE 3
Breusch-Godfrey Serial Correlation LM Test: F-statistic 0.544232 Probability Obs*R-squared 1.265210 Probability Test Equation: 0.587578 0.531206

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Dependent Variable: RESID Method: Least Squares Date: 10/06/08 Time: 19:24 Presample missing value lagged residuals set to zero. Variable Coefficient Std. Error t-Statistic C 0.882056 4.125673 0.213797 INFLATION -0.005956 0.106185 -0.056087 INVESTEMENT -0.043610 0.216242 -0.201670 RESID(-1) 0.110019 0.207352 0.530592 RESID(-2) -0.199688 0.210607 -0.948153 R-squared 0.045186 Mean dependent var Adjusted R-squared -0.120869 S.D. dependent var S.E. of regression 1.326369 Akaike info criterion Sum squared resid 40.46286 Schwarz criterion Log likelihood -44.88480 F-statistic Durbin-Watson stat 2.029693 Prob(F-statistic)

Prob. 0.8326 0.9558 0.8419 0.6008 0.3529 -3.00E-15 1.252815 3.563200 3.801094 0.272116 0.892907

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