Consumption and wealth in the US, the UK and the Euro Area : a nonlinear investigation

Abstract

This paper assesses the importance of nonlinearity in estimating the wealth effects on consumption for the US, the UK and the Euro area. We look at the impact of both (i) aggregate wealth and (ii) disaggregate wealth, namely, by comparing financial wealth effects with housing wealth effects. We also assess the magnitude of the response of consumption using both a linear model and two nonlinear approaches (a quantile regression and a smooth transition regression). We find that the elasticity of consumption with respect to aggregate wealth is largest for the UK and housing wealth effects do not seem to be relevant in the Euro area. As for the quantile regression, it shows that the sensitivity of consumption with respect to wealth and income variation is larger when consumption growth is abnormally high, i.e. during periods of economic booms. The smooth transition regression model is able to track reasonably well the consumption patterns during periods of economic downturn, financial instability and housing market corrections. Our approaches uncover a more complex dynamics of the relationship between consumption and wealth than previous results in the literature, whilst being in accordance with the theoretical background underlying the wealth effects on consumption.