WEALTH, DISPOSABLE INCOME AND CONSUMPTION - Economics

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
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