Public Expenditure and Consumption Volatility

Recent estimates of the welfare cost of consumption volatility find that it is significant in developing nations, where it may reach an equivalent of reducing consumption by 10 percent per year. Hence, examining the determinants of consumption volatility is of utmost relevance. Based on cross-country data for the period 1960-2005, the paper explains consumption volatility using three sets of variables: one refers to the volatility of income and the persistence of income shocks; the second set of variables refers to policy volatility, considering the volatility of public spending and the size of government; while the third set captures the ability of agents to smooth shocks, and includes the depth of the domestic financial markets as well as the degree of integration to international capital markets. To allow for potential endogenous regressors, in particular the volatility of fiscal policy and the size of government, the system is estimated using the instrumental variables method. The results indicate that, besides income volatility, the variables with the largest and most robust impact on consumption volatility are government size and the volatility of public spending. Results also show that deeper and more stable domestic financial markets reduce the volatility of consumption, and that more integrated financial markets to the international capital markets are associated with lower volatility of consumption.

Bibliographic Details

Main Authors:	Vincent, Bruno, Herrera, Santiago
Language:	English
Published:	World Bank, Washington, DC 2008-05
Subjects:	AGGREGATE CONSUMPTION, ANNUAL % GROWTH, AVERAGE GROWTH RATE, AVERAGE GROWTH RATES, BASE YEAR, BENCHMARKS, BUSINESS CYCLE, CAPITA GROWTH, CAPITAL ACCOUNT, CAPITAL ACCOUNT OPENNESS, CAPITAL MARKETS, CONSUMPTION EXPENDITURE, CONSUMPTION GROWTH, CONSUMPTION SMOOTHING, CONSUMPTION SPENDING, CONSUMPTION VOLATILITY, CONTROL VARIABLES, CURRENCY, DEPENDENCY RATIO, DEPENDENT VARIABLE, DEVELOPING COUNTRIES, DEVELOPMENT ECONOMICS, DISCRETIONARY FISCAL POLICY, DISCRETIONARY POLICY, DOMESTIC FINANCIAL MARKETS, DOMESTIC FINANCIAL SECTOR, ECONOMIC FLUCTUATIONS, ECONOMIC GROWTH, ECONOMIC POLICY, ELASTICITY, EQUITY MARKET, EXPLANATORY VARIABLES, EXPORTS, EXTERNAL FINANCING, FEDERAL RESERVE, FEDERAL RESERVE BANK, FINANCIAL DEVELOPMENT, FINANCIAL INTERMEDIARIES, FINANCIAL LIBERALIZATION, FINANCIAL OPENNESS, FINANCIAL SECTOR, FINANCIAL SECTOR DEVELOPMENT, FINANCIAL VARIABLES, FISCAL DISCIPLINE, FISCAL POLICY, FISCAL POSITION, FIXED EFFECTS, FLUCTUATIONS, GDP, GDP DEFLATOR, GDP PER CAPITA, GLOBAL ECONOMY, GOVERNMENT CONSUMPTION, GOVERNMENT SPENDING, GROWTH RATES, GROWTH VOLATILITY, HIGH INCOME, HIGH-INCOME COUNTRIES, HIGHER VOLATILITY, HOUSEHOLD BUDGETS, IMPORTS, INCOME, INCOME TAX, INCOMPLETE MARKETS, INFLATION, INSTITUTIONAL ENVIRONMENT, INSTRUMENTAL VARIABLE, INSTRUMENTAL VARIABLES, INTERACTION TERM, INTERNATIONAL CAPITAL, INTERNATIONAL CAPITAL MARKETS, INTERNATIONAL MONEY, LABOR SUPPLY, LATIN AMERICAN, LEVEL OF CONFIDENCE, LEVEL OF INCOME, LIBERALIZATION, LOW INCOME, LOW INCOME COUNTRIES, MACROECONOMIC STABILITY, MACROECONOMIC VOLATILITY, MARKET INFORMATION, MIDDLE INCOME, MIDDLE-INCOME COUNTRIES, MONETARY ECONOMICS, OIL PRICES, OPEN CAPITAL ACCOUNT, OPEN ECONOMIES, OPEN ECONOMY, OUTPUT, OUTPUT VOLATILITY, POLITICAL ECONOMY, POLITICAL SYSTEM, POLITICAL SYSTEMS, PRIVATE CONSUMPTION, PUBLIC EXPENDITURE, PUBLIC POLICY, PUBLIC SPENDING, REAL GDP, RISK AVERSE, RISK AVERSION, RISK PREMIUM, SIDE EFFECTS, SMOOTHING CONSUMPTION, STANDARD DEVIATION, STANDARD ERRORS, STEADY STATE, SUPPLY SIDE, SUPPLY-SIDE, TAX, TAX RATE, TRADE VOLATILITY, TRINIDAD AND TOBAGO, UNCERTAINTY, URBANIZATION, VOLATILITIES, VOLATILITY, WEALTH,
Online Access:	http://documents.worldbank.org/curated/en/2008/05/9473628/public-expenditure-consumption-volatility https://hdl.handle.net/10986/6692
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