Causal Links between Aggregate Consumption and Key Macro-Economic Variables: An Empirical Investigation from Sri Lanka
The study of aggregate consumption behaviour is significant because potential changes in the parameters of the consumption function may have some important policy implications. However, only a few studies are available in the estimation of aggregate consumption function after incorporating the impacts of fiscal policies for developing countries using time series data. This paper estimates the aggregate consumption function for Sri Lanka using time series data from 1978 to 2019 as there have been no studies relating to the issue in the country. The aggregate income (after adjusting tax), public expenditure, public debt, transfer expenditure and exchange rate have been used as explanatory variables in the model. The long-run marginal propensity to consume (MPC) is found to be 0.30 while short-run MPC is 0.71. Accordingly, the estimated short-run MPC is greater than the long-run MPC. The short and long-run coefficients of income indicate that any potential future income increases would result in significant increases in the consumption expenditure. The Granger-causality results detect uni-directional causality towards income to consumption. The results of this study can be used to make reformulate policies related to aggregate consumption behaviour in Sri Lanka.
KEYWORDS: Consumption, Fiscal policy, Income, Sri Lanka