A forward-looking model of aggregate consumption in New Zealand

An aggregate consumption function is estimated for New Zealand from 1974 to 1995. The instability of previous New Zealand models is addressed by using a broad measure of net wealth and a theoretically more sound measure of income. Households are assumed to be forward-looking, but only partly so. They form rational expectations of next year's real income, but thereafler use a simple rule of thumb: real income will grow at a constant rate. An econometrically stable cointegrating equation is estimated and it performs well out of sample. The main conclusions are that consumption closely follows net wealth over both short and long time horizons; it responds more to expectations of future household income than to current income; there is a strong negative relationship between savings and house prices, but no corresponding link to equity prices; and the impact of real interest rates on savings is positive but weak and possibly insignificant.