WEALTH, DISPOSABLE INCOME AND CONSUMPTION - Economics

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46 includes human wealth and non-human wealth (excluding equity). 9 The lower panel of Figure 14 focusses attention on the two most recent business cycles, reporting dynamic simulations starting in 1980. The graphs reveal that both EC models track the broad movements in consumption reasonably well. Prior to the 1980s, the Keynesian EC equation and wealth-augmented model have very similar dynamic forecasts, but in the 1980s there are some more marked differences. Although both equations underpredict the decline in consumption experienced during the 1981–82 recession, the equation including wealth explains a considerably larger proportion of the observed peak-to-trough decline – 85 per cent as compared with only 51 per cent for the Keynesian equation. The equation including wealth also tracks observed consumption more closely in the latter half of the 1980s. Strong growth in both human wealth and non-human wealth excluding equity through the 1987–88 period results in a considerably higher predicted level of consumption by the start of 1989, when wealth is included. As a result, the wealth-augmented model does a much better job of explaining the consumption boom in the late 1980s. This is consistent with the view that rising asset values, particularly housing prices, fuelled high levels of consumption over this period. Looking at the most recent recession, we see that neither equation can account for the magnitude of the fall in consumption through 1990 – both equations predict about half the observed decline. For the period following the recession, both equations predict little consumption growth through 1991 and 1992, with a slight pickup in 1993. While actual consumption growth remained weak in 1993, the tempting conclusion is that stronger consumption growth is just around the corner. 9. The dynamic simulations (not shown) for the model using total wealth are very similar though marginally inferior to those with human and non-human wealth (excluding equity) entered separately.
4 CONCLUSION The wealth measure developed in this study has significant explanatory power for consumption over and above the information already contained in current disposable income. This suggests that expected future income is an important determinant of consumption for at least some households. At the same time, disposable income remains an important determinant of consumption in both the short and the long run. One interpretation of this finding is that a significant proportion of households are liquidity constrained and therefore consume out of disposable income. An alternative interpretation is that wealth is measured with error, and this error is correlated with disposable income. Unfortunately, the results presented in this study cannot be used to discriminate between these two alternatives. A second finding is that fluctuations in equity prices have no significant impact on aggregate consumption of non-durables and services. A measure of non-human wealth that includes equity is found to have little explanatory power for consumption in either the long or the short run, while a measure that excludes equity is a significant long-run determinant of consumption. This finding may reflect the fact that most consumers simply do not hold equity or that a large proportion of the changes in equity prices are viewed as transitory. Estimates of dynamic EC consumption functions suggest that the negative effect of interest rates on consumption in a traditional Keynesian consumption function is due principally to the effect of interest rates on human wealth. When wealth is included among the regressors, the coefficient on the real interest rate remains negative, owing presumably to an intertemporal substitution effect, but this effect is not significant. For policy makers and practitioners, the most convincing evidence that wealth is an important determinant of consumption is probably that it is helpful in explaining both the severity of the 1981–82 recession and consumption boom of the late 1980s, both of which appear anomalous based on a traditional EC consumption equation that does not include wealth. While future work will no doubt improve empirical consumption 47
Page 1 and 2:
November 1994 WEALTH, DISPOSABLE IN
Page 3: CONTENTS ACKNOWLEDGMENTS ..........
Page 7 and 8: ABSTRACT The author develops a meas
Page 9 and 10: 1 INTRODUCTION Empirical research o
Page 11 and 12: impact of fluctuations in the price
Page 13 and 14: 2 MEASURING WEALTH In a competitive
Page 15 and 16: ∞ 1 + xt + j Ht = Xt 1 + E ⎛ t
Page 17 and 18: 2.3 percentage points) between the
Page 19 and 20: The time-series properties of net i
Page 21 and 22: expectation operator. Instead, the
Page 23 and 24: Table 3 Cumulative growth factors u
Page 25 and 26: 180 000 160 000 140 000 120 000 100
Page 27 and 28: non-residential structures, machine
Page 29 and 30: 80 000 70 000 60 000 50 000 40 000
Page 31 and 32: 3 IS WEALTH USEFUL IN EXPLAINING CO
Page 33 and 34: contrast, appears to be trend-stati
Page 35 and 36: First, there is little evidence tha
Page 37 and 38: Both estimators correct for the end
Page 39 and 40: cointegrating parameters reported i
Page 41 and 42: consumption, disposable income and
Page 43 and 44: Table 8 Error-correction models for
Page 46 and 47: 38 0.5 0.0 -0.5 -1.0 0.8 0.6 0.4 0.
Page 48 and 49: 40 conventional levels. Presumably
Page 50 and 51: 42 0.5 0.0 -0.5 -1.0 0.6 0.4 0.2 0.
Page 53: 15 000 14 000 13 000 12 000 11 000
Page 57 and 58: APPENDIX 1: The data This appendix
Page 59 and 60: TAX = taxes net of transfers = (NET
Page 61 and 62: = FINAQ_CD+FINAQ_CC+FINAQ_OBDS + FI
Page 63 and 64: CPPQ = Canada Pension Plan. D162590
Page 65 and 66: RAC = average coupon rate = RAC(t-1
Page 67 and 68: APPENDIX 2: Closed-form solution fo
Page 69 and 70: APPENDIX 3: Wealth and its componen
Page 71: 87:2 356297.31 295864.21 60433.10 3
Page 74 and 75: 64 Flavin, M. A. 1981. “The Adjus
Page 76 and 77: 66 Perron, P. 1991. “Test Consist
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