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

Penelope Smith and Lei Lei Song

Melbourne Institute Working Paper Series from 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.

Pages: 24 pages
Date: 2005-12
New Economics Papers: this item is included in nep-fmk
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