Consumption Function – I
ECN Data Analysis
Lawlor
Macroeconomic Time Series
• Data issue is to consider the nature of
economic series that move through time
• These are typically “dated”
– Annually, quarterly, monthly
• In economics these are often
Macroeconomic data
– History only happened once
Consumption Function
• Our example of this will be the estimation
of a “Consumption Function”
– For the United States in the post-war period
– Only years for which we have data
• Requires a very little bit of background in
Macroeconomic theory
Formal Theory of the Cons. Fn.
• Specifies the nature of the determinants of
real aggregate household consumption
(C).
• Asserts the major determinant of this in
short-run data (say quarterly or monthly) is
contemporaneous real income (Y)
• Describes this in the form of a general
function:
• C = f(Y,…)
Many attempts to estimate in many
data contexts
• 1st. step is to linearize the relation
• So we can use simple regression
• C = a + b*Y
– Where,
• a = intercept of cons function, sometimes
interpreted as “autonomous consumption”
– that part of C not caused by changes in Y
• “b” = the slope of the consumption function
• sometimes interpreted as “induced consumption”
– that part caused by changes in Y
Data derived Cons. Fn.
• If you were to display the
contemporaneous data on C and Y on a
scatterplot…
• Do so on Gretl
• Show on board
• Derive: MPC, MPS, a
• One of the most stable relationships in
economics
Show how data implies “the
fundamental psychological law:
• This form of the “fundamental
psychological law”
–0<a
– 0 < b, or MPC < 1
– Says that, in the short-run, “when household
income increases, so does household
consumption, but not by as much”
• Again, 0 < MPC < 1
Now look at origin of Cons. Fn.
• JMK, writing in the Great Depression
• Reading Keynes:
– Choice of units
• Discussion of the precision with which
macroeconomic time series data are measured
– Can we really rely on aggregate P and Y the over longperiod? Think how we define real C and real Y.
» JMK says no, reason we should confine
macroeconomics, an macroeconomics to the shortrun- say a decade, or the time span between usual
business cycles
JMK on the “Propensity to
Consume”
• pp. 12-14 in text selection
• States a verbal form of “fundamental
psychological law”
– namely that people are disposed to “increase
their consumption as their income increases,
but not by as much as the increase in their
income.”
• Says the MPC is “positive and less than unity”
• Note, for us, this importantly corresponds to the
data of repeated attempts to estimate the cons. fn.
Two additional hints from JMK,
worth storing away for later study
• 1. He suggests that many other factors
may co-determine the consumption levels
of different countries
– Seen today in wildly different MPC’s across
the globe
– His choice for the most important measurable
variable is “windfall changes in capital values”
• 2. He suggest MPC may fall at as Y drifts
higher
Keynes and the Data
• Use Gretl – “Browse Databases”
• Explore and install various series from the
St. Louis Federal Reserve
• Want to find and open variables that
measure C and Y
• In series “find” window search for
“consumption” and “income”
– Looking for “real” personal consumption and
disposable income of households
Plot and explore the Data
• Note first the nature of the data: monthly, real,
seasonally adjusted, from 1959:01 to 2007:06
• Highlight both and display as “time series plot”
• Note how good it fits our conception of “fund.
psych. law”
• Note we can use the mouse to figure out what
year we are looking at
• Note it is over “long-run” data from 1959 to
present – should this be a problem?
Explore, contd.
• Note you can “zoom” in on a particular
time period in the “edit” menu
• Show it in a “scatterplot”
• Comment on the “line of best fit”
– Note the value of the intercept, pos., neg, O
• Select “Model” and estimate an “OLS”
regression
– Interpret the coefficients and output
The Cons. Fn. And the U.S. “Great
Depression”
• Think of the historical context
– Great uncertainty about employment, extreme
frugality
• Why? As seen in figs. on 4, a collapse of Y
and C and I
• Fig. 11 on p. 5, shows the stability of
spending on consumption versus the
excessive volatility of investment
Estimate a Cons. Fn. For these
years
• Last page shows this
• First figure is the material out of which a
consumption function is made
– notice C > Y in 1932-1934
– Think about that and annual data (all
available)
• Now run the regression: results graphically
displayed in second figure
– Note the very high MPS, = .76