An investigation of the Norwegian consumption function : income distribution and wealth effects

Abstract

Since the financial crisis, Norwegian private consumption has fallen as a share of disposable income. This weak development in consumption was not predicted by the contemporaneous consumption models and led to a “structural breakdown” of these models. This master’s thesis will attempt to build a new model for aggregate consumption that is better able to explain the developments since the financial crisis. This is done by using cointegration analysis to estimate a long run relationship and then include this in an error correction model for private consumption. With a basis in the current consumption function in Statistic Norway’s KVARTS model, I first show the breakdown of the contemporaneous model and then conduct two separate analyses into possible explanations for the breakdown. First, I find that the income distribution, measured by a Gini coefficient or the wage share, do not seem to affect household consumption on the aggregate level. Second, I split the wealth variable present in the current model into different components. In the long run, including net housing wealth and net financial wealth separately seems to improve the model. Financial wealth is a larger determinant of household consumption in the long run than housing wealth. In the short run, the degree of liquidity affects the effect of financial wealth on consumption, while controlling for short run dynamics of debt does not improve the model.