Econometric modeling of the aggregate time-series relationship between consumption expenditure and income : an international analysis

This study analyzes the relationship between consumption expenditure and income for 13 OECD countries over the period 1950-1982. The analysis is done on a country-by-country basis and pooled cross-section time-series framework. It is indicated that the theoretical models of consumption point to a more general autoregressive distributed lag model than is usually estimated. The update of some of the previous empirical studies are provided and their statistical inadequacies are highlighted. It is shown that most of the above models, at a minimum, suffer from dynamic misspecfication. As an alternative Davidson, Hendry, Srba and Yeo(1978) Error Correction Mechanism (ECM) is utilized and empirically evaluated. Moreover, using Davidson et al. methodology on dynamic specification analysis country-specific models of consumption are obtained. Through a battery of diagnostic tests it is shown that the latter models do not suffer from the statistical inadequacies that are found in the previous studies. Also, it is shown that the pooled results support the above ECM model. In particular, the pooled "within" estimator indicates a large and significant disequilibrium term while the "between" estimator indicates a small and insignificant disequilibrium term. This is consistent with the belief that the within estimator tend to yield short-run estimates while the between estimator tend to yield long-run estimates. It is concluded that on a country-by-country and pooled bases the modeling procedure expounded by Davidson et al. has the potential to provide a parsimonious approximation to the data generation process.