Loss aversion or hand-to-mouth behaviour in private consumption models

Abstract

This study empirically tests whether the loss aversion or hand-to-mouth theories of consumption behaviour is present in Fiji. The loss aversion hypothesis implies that consumers would maintain their consumption when income falls. To estimate this model, we apply the nonlinear autoregressive distributed lag model with annual data from 1981 to 2019. Our findings are in contrast to the predictions of the loss aversion hypothesis and support the hand-to-mouth hypothesis in Fiji. The results are robust to alternative measures of liquidity, and a sample that includes the COVID-19 pandemic. We contribute to the literature by providing evidence of nonlinearity’s in the consumption-income association. The findings are useful for policymakers in developing countries for policies on economic growth and stabilization.

KEYWORDS:

• Private consumption
• prospect theory
• loss aversion
• hand-to-mouth
• Fiji

JEL:

• E21
• E31
• E52

Disclosure statement

No potential conflict of interest was reported by the author(s).

Notes

1 In Leeper and Gordon (1992), this is referred to as the Friedman-Cagan analysis.

2 We thank associate editor of New Zealand Economic Papers, Dr Asha Sundaram, for highlighting this point.

3 We thank an anonymous reviewer for suggesting to include the COVID-19 period and M2 in the specification.