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Liquidity Effects and Precautionary Saving in The Czech Republic

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  • Bredin, Don

    (Central Bank and Financial Services Authority of Ireland)

  • Cuthbertson, Keith

    (Imperial College, London)

Abstract

Since the break up of the Czech-Slovak Federation on 31 December 1992, the Czech Republic has been at the forefront of the transition to a market economy. Key aims of the Czech Republic, and many other former centrally planned economies, are low inflation and a stable exchange rate, particularly for those who ultimately wish to enter the European Union (EU). The aggregate consumption function has been a key component of macro-models since Keynes and is especially important for growth in a transitional economy. Key economic variables will be used to explain the consumption function, e.g. real houshold income, interest rates on credit, inflation and real wealth. We expect a positive relationship between real consumption and the level of real income and wealth, with a negative relationship between the consumption and the rate of interest and inflation. The estimation approach we use is an error correction model. Given the nature of the Czech financial markets and institutions it is likely that consumption will not immediately reach the long-run equilibrium. Therefore the long-run relationship and short-run interactions which is the basis of the error correction model approach would appear to be the appropriate choice for an emerging economy. The data used in the study is monthly and runs from January 1993 to April 1995. All the required data are taken from the CNB, Financial Statistics Report. Given that the Czech Republic has been hit by a number of different shocks over the relatively short transition period, we will estimate the empirically based consumption functions starting from 1993. Due to the paucity of data we initially include only standard variables associated with the consumption function; real disposable income, interest rates and inflation. We do however test a number of variants, including using an alternative measure of income, namely real wage income. We also include the unemployment rate which would proxy liquidity constraints. Also if there is an increase in the probability of unemployment current liquidity, future liquidity or uncertainty - or all three - may lead to a reduction in current consumption. Although we are faced with a limited data set we do however find a number of interesting results. Of particular note for a transition economy, such as the Czech Republic, is the long-run relationship between real consumption and wage income, interest rates, inflation and the rate of unemployment. We take the change in unemployment to reflect changes in liquidity constraints and the level of unemployment to reflect precautionary saving. The results imply that these effects are present and statistically significant both in the short and long-run. Our results also indicate that the long-run income elasticity is affected by the inclusion of the unemployment term.

Suggested Citation

  • Bredin, Don & Cuthbertson, Keith, 2001. "Liquidity Effects and Precautionary Saving in The Czech Republic," Research Technical Papers 4/RT/01, Central Bank of Ireland.
    • Handle: RePEc:cbi:wpaper:4/rt/01
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    References listed on IDEAS

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    Cited by:

    1. Aleksandar Vasilev, 2015. "Modeling Real Private Consumption Expenditure in Bulgaria after the Currency Board Implementation (1997-2005)," Zagreb International Review of Economics and Business, Faculty of Economics and Business, University of Zagreb, vol. 18(1), pages 81-89, May.
    2. Frank Barry & John Bradley & Michal Kejak & David Vavra, 2003. "The Czech economic transition," The Economics of Transition, The European Bank for Reconstruction and Development, vol. 11(3), pages 539-567, September.
    3. Bill Martin, 2009. "An Augmented UK Private Expenditure Function," Working Papers wp384, Centre for Business Research, University of Cambridge.

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