Aggregate Consumption and Debt Accumulation: An Empirical Examination of US Household Behavior
Trinity College Department of Economics Working Paper No. 12-04
54 Pages Posted: 27 Jun 2012
Date Written: June 27, 2012
The outbreak of the financial crisis in 2008 witnessed a marked contraction in US consumption spending that had hitherto been boosted by historically high levels of household debt-financing. These events question the validity of conventional models of consumption based on the life-cycle hypothesis, with its benign view of debt as a neutral instrument of optimal intertemporal expenditure smoothing. This paper develops an alternative account of consumption spending based on the Keynesian relative income hypothesis, which claims that current income, its distribution, household borrowing, and household indebtedness all affect current consumption. The paper then provides an empirical investigation of US consumption spending since the 1960s. The results of this inquiry are not compatible with the life-cycle hypothesis, but are congruent with our alternative Keynesian theory of consumption based on the relative income hypothesis.
Keywords: Consumption, household borrowing, household debt, life cycle hypothesis, relative income hypothesis
JEL Classification: E12, E21
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