Determinants of Consumption and Savings Behavior in Developing Countries

The determinants of savings generally and the specific effects of government policies on savings and consumption are pivotal forces in investment and economic growth. The Hall hypothesis states that consumption is a function of lifetime (“permanent”) income, rather than income in each period independently. Changes in interest and tax rates, money supply, or government expenditure will affect permanent income and hence consumption and savings only if they are unexpected and thus not already incorporated in the estimation of permanent income. We are unable to reject the Hall hypothesis in tests for developing countries when we allow for varying interest rates. We do find evidence of a negative effect of inflation on consumption, and a positive relationship between the real interest rate and consumption. The evidence for the Hall hypothesis also suggests that Ricardian equivalence may be valid—this is Barro's hypothesis that the effect on savings is the same whether government deficits are financed through taxation or debt. Our preliminary testing, however, does not support Ricardian equivalence.