Consumption Pattern: Open Economy Setting

Since the publication of Keynes' General Theory of Employment, Interest, and Money in 1936, economists have been noting consumption functions. None of these studies, however, have included the effect of openness on aggregate consumption, despite the fact that the degree of openness has been increasing significantly in recent years, leading to a significant portion of consumption met through imports. This paper proposes an estimation of the consumption function in an open economy setting. A consumption function model is developed using annual time series data from India for the period 1973 to 2006. The time series properties of the data are diagnosed, and two versions of the error correction model are developed. Estimation of both versions of the model supports the proposition that the exchange rate is an important determinant of the aggregate consumption function in the Indian economy.