Household consumption behaviour

Household consumption expenditure remains the dominant component of aggregate expenditure both in developed and developing countries. Whether household consumption expenditure remains stable over time or exhibits volatility remains a debatable issue. The factors that affect household consumption behaviour have also been an area of intensive study over the past few decades. ¹ The importance of household consumption behaviour originates from its policy implications for short-run economic fluctuations and long-run trends in output and employment (Molana, 1992). For example, in the literature this issue has been investigated in the context of whether there are roles for fiscal and monetary policies in smoothing business cycles. In the Keynesian literature, as inspired by Keynes (1936), consumption spending depends on current income and is therefore sensitive to exogenous shocks and policy measures. Since consumption is a linear function of disposable income, changes in taxes, transfer payments and windfall gains impact on household consumption. The government can thus have a major stabilizing role in aggregate demand when the economy encounters cyclical expansion or contraction. Formally, in the Keynesian literature, the marginal propensity to consume out of current income is very high, which makes the size of the multiplier ² high and creates a large dynamic impact upon the economy of any policy-induced or exogenous shock to consumption expenditure. Given the large size of the multiplier, discretionary fiscal policy measures can thus have a major impact on the macroeconomy.