Keeping up with the Joneses: macro-evidence on the relevance of Duesenberry’s relative income hypothesis in Ethiopia*

Abstract

Despite being mysteriously ignored and displaced by mainstream consumption theories, Duesenberry’s relative income hypothesis appears to be highly relevant to modern societies where individuals are becoming increasingly obsessed with their social status. Accordingly, this study aims to provide some evidence on relative income hypothesis by investigating the relevance of Duesenberry’s demonstration and ratchet effects in Ethiopia using quarterly data from 1999/2000Q1 to 2018/19Q4. We estimate two specifications of the relative income hypothesis using the traditional Autoregressive Distributed Lag (ARDL) model and the dynamic ARDL simulations approach. The findings confirm a Backward-J-shaped demonstration effect, implying that an increase in relative income induces a steeper reduction in Average Propensity to Consume (APC) at lower-income groups (the demonstration effect is stronger for lower-income groups). The results also support the ratchet effect, indicating the importance of past consumption habits for current consumption decisions. In resolving the consumption puzzle, the presence of demonstration and ratchet effects reflects a stable APC in the long run. Therefore, consumption-related policies should be carefully designed, as policies aimed at boosting aggregate demand can motivate low-income households to gallop into a wasteful competition to ‘keep up with the Joneses’—the relative riches.