Determinants Of Private Consumption In Developing Countries Economics Essay

introduction

“Consumption and macroeconomic policies, evidence of asymmetry in developing countries” by “Magda Kandil”, and “Ida Aghdas Mirzaie” paper examines determinants of private consumption in a sample of developing countries. The empirical model includes income, a proxy for the cost of consumption, and the exchange rate. Anticipated movements in these determinants are likely to trigger adjustment in planned consumption, while unanticipated changes determine random transitory adjustment in consumption. Fluctuations in private consumption are mostly random with respect to unanticipated changes in income and, to a lesser extent, the exchange rate. Consumption increases during cyclical expansion of income and decreases in the face of an unanticipated increase in the cost of consumption. Exchange rate fluctuations have mixed results on private consumption. As for the effects of domestic policies, fiscal policy has a limited, and sometimes negative, effect on private consumption. Monetary growth, in contrast, stimulates an increase in private consumption. This evidence supports recent calls to decrease the size of government and enhance the role of monetary policy in stimulating private activity in developing countries.

Consumption spending is an important part of the aggregate demand, the change in consumption determines change in saving rate, and in turn saving /investment balance. This (saving/investment) balance is an image of the current account balance, when any increase in consumption will lower the (N) income, which makes the economy relying on foreign recourses there for the study of the behaviour of private consumption of some developing countries is a necessity, and the key question is: why is private consumption not growing smoothly with the income. With paying attention to the fact that savings are generally high in developing countries, which indicates the uncertainty (fluctuate confidence) of consumer towards the economic outlook. These high, unstable savings reflect the effect of the consumption on the economic growth.

There must be a positive response of the private consumption to the real growth, in order to reduce the pressure on the price inflation. In this paper as the title shows, the writers using a rational expectation model tried to study the role of stabilization policies in determining planned and cyclical consumption, using fiscal and monetary policies.

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Literature review:

As hall(1987), Manikw ( 1989), and Starr(1979, and many others have shown in recent studies, the consumption expenditure follows a random pat, and only unexpected policies canaffect it, and consumption depends on current income. This theory holds more strongly in the developing countries because of the lack of capital, and the use of cash payments instead of using credits.

So in this study, “Mgda Kandil” and “Ida Aghdaa Mirzaie” separated private consumption spending into a planned component that changes with the policy avariables, and a cyclical component that varies with surprises, like unanticipated policy shocks, and the objective is to study both cyclical and planned consumptions.

Theoretical background:

the specification below describes the demand and the supply sides of the macroeconomic, when “t” denotes the current value of the variables:

The equations describe the demand and supply sides of the macro-economy, where equation (1) shows that real consumption c varies according to real income yd, interest rate int , and currency appreciation (rer), in a positive, negative, and positive ways respectively.

In equation (2) the nominal interest rate is the sum of real interest r and the inflationary expectations, where pt is the price level and (Et) is the agent’s forecast.

In equation(3), disposal income is the net real income (yt) minus taxes t. While equation (4) shows that real taxes are linear functions of real income. And equation (5) says that real investment expenditure (i) vary negatively with the real income. When equation (6) indicates that real export is related to (Xo) which moves in a positive way with the income, and the negative relationship between (Xt) and (rer) shows that export decrease when domestic price is higher relatively to foreign price.

From equation (7) real imports (im) moves positively with real income and with real exchange rate. And from equation (8) we can see the equilibrium condition in the goods market, when equation (9) describes the equilibrium in the money market and equation (10) is for the aggregate supply, which arise according to the output supply So of the production function, and output price surprises, (Pt-Et-1 Pt)

Combining aggregate demand and supply we solve for output surprises as a function of monetary surprises and government spending surprises, and exchange rate surprises, then substituting the solution for output price surprises into the output supply, we solve for (Yt). And substituting (Yt) into the aggregate demand equation, we solve for the price level which changes with expected and unexpected policy changes.

The shift in private consumption responding to an anticipated change shifts in the economy identifies the long-term path of consumption, and the shift that occurs in respond to unanticipated economic shits represents the short-term change of consumption.

After solving disposal income and interest rate we solve for private consumption, which will be varying according to anticipated change in the policy variables, government spending and the money supply. As well as anticipated change in the exchange rate as follows: _

The increase in government spending will increase the income and the interest rate, and an increase in the money supply increases the income and decrease the real interest rate (liquidity effect). Also an appreciation of the real exchange rate decreases the cost of imports and thus the consumption of non-tradable decreases.

Conclusion

 The evidence sheds new light on the determinants of private consumption in a sample of developing countries and distinguishes between planned and cyclical consumption. The cyclicality of private consumption and its significant fluctuations support calls to decrease the role of government and enhance the role of monetary policy in stimulating private activity in developing countries. The public sector remains a major source of employment in many developing countries. Nonetheless, soaring budget deficit has continuously raised concerns about the stability of real income growth. Agents in many developing countries are forced to maintain high saving rates to hedge against expected inflation. These rates vary considerably with uncertainty impinging on the economic system over time. Private savings may provide liquidity to finance additional government spending. Nonetheless, unproductive spending by the government and soaring budget deficits generate concerns about unsustainable growth and aggregate uncertainty that reflect negatively on private consumption, let alone the adverse effects on private investment.