The DHSY Model and Asymmetric Consumption
The failure of models of aggregate consumption to predict the consumer expenditure boom in the late 1980s is well- documented. This has generated a large theoretical and empirical literature in an attempt to refine our understanding of aggregate consumer spending behaviour. In this paper we assess the possibility that, in the aggregate, consumers respond differently to different types of disequilibrium error. We illustrate the idea using an Engle-Granger approach to the DHSY model. The disequilibrium error is endogenously determined by the empirical model and a binary dummy variable captures two alternative states (above and below equilibrium), which is then interacted in a dynamic empirical model of consumer spending. Income elasticities, inflation elasticities and speeds of adjustment are all seen to change significantly in response to the type of disequilibrium error, suggesting some form of asymmetric behaviour on the part of consumers. Moreover, the asymmetrically augmented DHSY model substantially outperforms the standard DHSY model with standard error improvements in excess of 50%.
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