Econometric Evaluation of Consumers' Expenditure Equations

Large errors in forecasting consumption in the late 1980s and early 1990s were a major contribution to the poor performance in economic forecasting overall. These errors have been attributed to the inability of existing models to capture important influences on consumer behavior, such as the effects of financial deregulation and shifts in expectations. Revisions to models followed their failure to predict the late 1980s boom; an important question is whether these developments help to explain the unanticipated downturn in consumers' expenditure in the early 1990s. This article presents an appraisal of eight recent U.K. consumption functions. It is found that these models can explain much of the rise in consumption in the late 1980s. However, forecast errors for the early 1990s, while within the historical range, are predominantly negative. The nature of this overprediction suggests that further research on household finances, including the role of housing as collateral, is required. Copyright 1994 by Oxford University Press.