Financial inclusion, household consumption instability and democracy in developing countries: A finite mixture of regressions approach

Abstract

The literature on the impact of financial inclusion on the instability of household consumption remains controversial. In this article, we considered the possibility that countries follow different regimes of household consumption instability and tested the hypothesis of whether financial inclusion is countercyclical or procyclical to a country's regime of consumption instability. Thus, relying on recent works that used the finite mixture regression method, we identify the different regimes of household consumption instability. Drawing on a sample of 28 developing countries over the period 2011–2020, the paper highlights that the impact of financial inclusion on consumption instability differs across classes and a three-class model best describes the sample. Specifically, we show that financial inclusion is positively associated with consumption instability in the first class, while financial inclusion significantly reduces consumption instability in the second class. Financial inclusion does not have a significant impact on the third class. Furthermore, exploring the potential role of democracy in determining class affiliation, the results emphasize that developing countries would fully benefit from financial inclusion by undertaking strong reforms to improve democracy.