How Does the Sensitivity of Consumption to Income Vary Over Time? International Evidence

27 Pages Posted: 17 May 2016

See all articles by Ergys Islamaj

Ergys Islamaj

World Bank

M. Ayhan Kose

World Bank; Brookings Institution; Centre for Economic Policy Research (CEPR); Australian National University (ANU)

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Date Written: April 29, 2016

Abstract

This paper studies how the sensitivity of consumption to income has changed over time as the degree of financial integration has risen. In standard theory, greater financial integration facilitates international borrowing and lending, helping to reduce the sensitivity of consumption growth to fluctuations in income. The paper examines the empirical validity of this prediction using an array of indicators of financial integration for a large sample of advanced and developing countries over the period 1960-2011. Two main results are reported. First, the sensitivity of consumption to income has declined over time as the degree of financial integration has risen. The decline has been more pronounced in advanced economies than in developing ones. Second, the regression analysis indicates that a higher degree of financial integration is associated with a lower sensitivity of consumption to income. This finding is robust to the use of a wide range of empirical specifications, country-specific characteristics, and other controls, such as interest rates and outcome-based measures of financial integration. The paper also discusses other potential sources of the temporal changes in the sensitivity of consumption to income.

Keywords: Consumption, Debt Markets, Inequality, Economic Theory & Research, Emerging Markets

Suggested Citation

Islamaj, Ergys and Kose, M. Ayhan, How Does the Sensitivity of Consumption to Income Vary Over Time? International Evidence (April 29, 2016). World Bank Policy Research Working Paper No. 7659, Available at SSRN: https://ssrn.com/abstract=2781016

Ergys Islamaj (Contact Author)

World Bank ( email )

1818 H Street, NW
Washington, DC 20433
United States

M. Ayhan Kose

World Bank ( email )

1818 H Street, NW
Washington, DC 20433
United States

Brookings Institution ( email )

1775 Massachusetts Ave, NW
Washington, DC 20036
United States

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

Australian National University (ANU) ( email )

Canberra, Australian Capital Territory 2601
Australia

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