Neoclassical economists study
consumption an absolute determination of economic activity, thus consumption level
per individual is considered as a principal measure of an economy’s dynamic achievement.
The effects of interest rate on consumption is a major concern for an economy.
Economists use correlation between consumption and interest rate to make
decisions. Thus, it is crucial to separate consumption decision from other influences
to measure an accurate effect of interest rates upon consumption.
Classical economists believed that
consumption is a function of interest rates which has attained little consideration
in empirical studies on consumption function. The latter found that the impact
of interest rates on consumption and saving had not established a clear relationship,
positive or negative among interest rates consumption. However, earlier study established
that debt played a main part for consumption decisions of households through financial
crisis and debt and house price growths are vital aspects to recognize
macroeconomic instability. For instance, an opposing link among domestic
leverage when entering financial crisis and consumption growth throughout the
crisis has now been set up in numerous countries Andersen et al. (2016), Dynan
(2012), Fagereng and Halvorsen (2016). Furthermore, major boom-bust cycles of
most procedures of private debt have been renowned Garriga et al. (2017).
Keynes (1936) made a consumption
function which bounded present income as the only factor of consumption. Advanced
growths reflected consumption as determined by relative income and stable
income Duesenberry (1949) and Friedman (1957). However, Ando and Modigliani
(1963) assess consumption function as a lifespan income instead of present
In contrast, empirical studies by Weber
(1975) and Springer (1975), stated a substantial and positive effect of interest
rate on consumption. Weber (1970), did an empirical test with total statistics
from US yearly data for period 1930 to 1965. He then detected that an increase in
rate of interest rises total consumption. The precise total consumption
functions are results from people maximum utility for several period. This method
match to that of Richard Brumberg (1954), Franco Modigliani (1953) and Milton
Friedman, except the impacts of interest rate are not assumed away. Whereas
Houthakker, Weber and Taylor did not ponder interest rates in actual terms,
Springer measured interest rate in real terms. Actually, Weber (1975) proved
that inflation had minor impact on total consumption.
Wright (1967, 1969), Taylor (1971), Heien (1972), Blinder (1975) and Boskin
(1978) projected opposite link among consumption costs and interest rate.