The Consumption Function: A New Perspective

The behaviour of aggregate consumption is conventionally understood from the perspective of the permanent income and life cycle hypotheses. Both of these hypotheses are deduced from the theory of constrained optimization as applied to a ‘representative agent’ that consumes and saves. An alternative way of understanding aggregate consumption expenditure is to see it as primarily a systemic outcome of the adoption of widely upheld rules (‘meso-rules’) that enable trading and contracting in a complex economic system. Such systems require order to function but they must also adapt and evolve. Correspondingly, aggregate consumption can be viewed as being determined by two contrasting historical processes: one involves an aggregation of pre-committed, rule-bound choices and the other open-ended aspirational choices of novel products. Both of these processes are influenced by economic incentives. This is the domain of neoclassical economic theory and it is found that such theorising can tell us a great deal once it is set in its proper historical context. Although a modern complex system perspective derived from the natural sciences is adopted, it is embedded in economic thinking. For example, connections are made to the insights and intuitions of Alfred Marshall, Joseph Schumpeter, Simon Kuznets, Friedrich Hayek and Maynard Keynes. What we understand from them, along with modern complex system analysis, is that, although it is individual decisions that are fundamental in any economic system, it cannot be the case that what we observe at the aggregate level just reflects the optimization decision of a representative agent. As Hayek observed, the role of individual is much more complex and important than this. Using half a century of data, the US consumption function is modelled successfully on the presumption that the economy is a complex system in which there has been the diffusion of a ‘culture of consumerism’ in the post-war era. This has involved the increasing adoption of a particular bundle of meso rules and this has resulted in a steadily increasing ratio of consumption to GDP that has been tending towards a limit. It was found that variables and perspectives drawn from neoclassical economic theory are important in explaining variations in the growth of aggregate consumption.