US inflation and consumption: A long-term perspective with a level shift

This article examines the existence and stability of the consumption function in the United States of America (US) beginning in the 1950s. In order to obtain a stable long run relationship, we have introduced two innovative elements into the analysis of the life-cycle of the consumption function with wealth effects: 1) a shift level break in the cointegrating relationship, and 2) using inflation as an additional explanatory variable. By implementing a well structured estimation strategy, we found that after taking the level shift into account, a cointegrating equation, including inflation, exists and is more stable for the critical sub-samples than traditional consumption function models.

► We examine the consumption function in the U.S. beginning from the 1950s. ► To obtain a stable long-run relationship, we introduced two innovative elements. ► First: a shift level break in the cointegrating relationship ► Second: inflation as an additional explanatory variable