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Response of Consumption to Income, Credit and Interest Rate Changes in Australia

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  • Penelope A. Smith

    (Melbourne Institute of Applied Economic and Social Research, The University of Melbourne)

  • Lei Lei Song

    (Melbourne Institute of Applied Economic and Social Research, The University of Melbourne)

Abstract

This paper examines the response of consumption to income, credit and interest rate changes in Australia. In contrast to previous studies on consumption in Australian, this paper adopts an Euler equation approach. The Euler equation derives from the consumers' utility maximising problem under the assumption that rule of thumb consumers have borrowing restrictions. To assess the role of credit explicitly, credit variables are also included in the Euler equation. The paper further assumes that coe±cients are time-varying. The results con¯rm the signi¯cant e®ects of income and credit on consumption and also reveal that while consumption growth is not responsive to interest rate changes, the coe±cient on the real interest rate was time varying and the coe±cient becomes smaller in absolute terms since the mid 1990s. This implies that consumption may have been less responsive to interest rate changes since then.

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Bibliographic Info

Paper provided by Melbourne Institute of Applied Economic and Social Research, The University of Melbourne in its series Melbourne Institute Working Paper Series with number wp2005n20.

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Length: 24 pages
Date of creation: Dec 2005
Date of revision:
Handle: RePEc:iae:iaewps:wp2005n20

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Postal: Melbourne Institute of Applied Economic and Social Research, The University of Melbourne, Victoria 3010 Australia
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  1. John Y. Campbell & N. Gregory Mankiw, 1991. "Permanent Income, Current Income, and Consumption," NBER Working Papers 2436, National Bureau of Economic Research, Inc.
  2. John Y. Campbell & N. Gregory Mankiw, 1989. "Consumption, Income and Interest Rates: Reinterpreting the Time Series Evidence," NBER Chapters, in: NBER Macroeconomics Annual 1989, Volume 4, pages 185-246 National Bureau of Economic Research, Inc.
  3. Olivier Blanchard & John Simon, 2001. "The Long and Large Decline in U.S. Output Volatility," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 32(1), pages 135-174.
  4. Hansen, Lars Peter & Singleton, Kenneth J, 1983. "Stochastic Consumption, Risk Aversion, and the Temporal Behavior of Asset Returns," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 91(2), pages 249-65, April.
  5. Hahm, Joon-Ho, 1998. "Consumption adjustment to real interest rates: Intertemporal substitution revisited," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 22(2), pages 293-320, February.
  6. Lawrence J. Christiano & Martin Eichenbaum & David Marshall, 1990. "The permanent income hypothesis revisited," Staff Report, Federal Reserve Bank of Minneapolis 129, Federal Reserve Bank of Minneapolis.
  7. Smith Penelope & Summers Peter M, 2009. "Regime Switches in GDP Growth and Volatility: Some International Evidence and Implications for Modeling Business Cycles," The B.E. Journal of Macroeconomics, De Gruyter, De Gruyter, vol. 9(1), pages 1-19, September.
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