RDP 9512: Consumption, Investment and International Linkages 5. Conclusion

In conclusion, the results suggest some evidence of a direct link flowing from foreign indicators to domestic consumption or domestic investment. That there is a relationship is again highlighted by the ability of the Gruen and Shuetrim type explanators to explain real household disposable income in the consumption framework. Movements in US activity through the 1970s and Japanese activity innovations in the 1980s seem to provide information about movements in domestic permanent income and hence influence consumption decisions in a direct sense.

However, it appears that overseas developments provide little information about future profitability and hence investment. An indirect channel was identified operating through business confidence but this channel operates with a lag and has a small impact on aggregate investment. However, in estimating the investment equation it is likely that cash flows, for instance, capture part of the information provided by business confidence – mitigating the estimated direct effect of confidence on investment, and thus potentially understating this channel of foreign influence.

The analysis also bore some additional fruit concerning domestic consumption and investment behaviour. Estimation of the consumption equation provided evidence that the degree of liquidity constraints has declined in the deregulated period in Australia. Further, the estimated investment equations confirmed the findings of other studies that cash flow is a significant determinant of the level of investment.

The principal objective of this paper was to understand the strong contemporaneous linkage identified by Gruen and Shuetrim. While evidence of a consumption channel through Japan was identified in the 1980s, results for an investment channel through business confidence were neither strong nor immediate. The lack of strong evidence for the US and OECD may be due to the strong collinearity between the growth rates of those variables and domestic output growth.

Furthermore, the model presented by GS is an aggregate specification. The numerous interconnections of economic activity are often better captured by aggregate quantities.^[17] Aggregate quantities by their nature are, in part, the product of nonlinearities and economic subtleties. Hence, the combined effects operating through consumption and investment may underpin the aggregate result, given a specification that adequately models feedback and multiplier effects. For example, the increase in business confidence leads to a rise in investment which in turn generates increased cash flow leading to further increases in investment, while also increasing household disposable income which increases consumption.

Footnote

Duguay (1994) finds that an aggregate equation captures the transmission mechanism in Canada better than a more disaggregated approach. [17]