SINGAPORE CONSUMPTION FUNCTION : AN APPLICATION OF COINTEGRATION TECHNIQUES

Abstract

Although the aggregate consumption function has been thoroughly researched and estimated in many countries such as the United Kingdom and the United States, there have been very few quantitative studies of this nature in Singapore. This exercise is an attempt to add to what little there is and to obtain a better representation of the Singapore consumption function that is derived from a more adequate and sound framework than just levels regression. This exercise takes a brief look at the history of the consumption function, tracing the theories that had an important impact in its development from the time it took root in Keynes' General Theory in 1936. Specifically, the Absolute Income hypothesis, the Life Cycle and the Permanent Income hypotheses, and the Rational Expectations/Random Walk approach are described. Unfortunately, there existed shortfalls in these approaches: there were contradictions between the implications of the theories, particularly the Absolute Income hypothesis, and the empirical findings; empirical evidence were not very supportive of the Rational Expectations approach. Furthermore, there were the problems associated with levels regression which rendered the standard approach that was applied to time-series erroneous. Thus, there was a need to have an econometric model to consumer behaviour that would understand the underlying data-generating process and that would provide a more adequate and sound framework for the estimation of the consumption function. The Cointegration technique boasts of this and its associated Error Correction Model is able to provide a better and more consistent estimation of the consumption function. Thus, the objectives of this study are to utilise the cointegration procedure to provide a consumption function that is consistent with the Singapore experience and void of the problems mentioned as well as to study the relationship between consumption expenditure and income. This dissertation gives an outline of the history and concept of cointegration. A description of its technique is also given. Finally, the results of two analyses, one using annual data and the other using quarterly data, are presented together with an error correction model that can be used to represent Singapore's Consumption Function.