The roles of relative prices, interest rates, and bequests in the consumption function

Abstract

This paper investigates the roles of relative prices, interest rates, inflation expectations and bequests in the determination of consumer expenditures for four goods in the U.S. The framework employed is a life-cycle extension of the Linear Expenditure System, in which relative prices, wealth, labor income, the nominal interest rate, and anticipated rates of inflation for each good are major arguments. The results provide strong empirical support for the expenditure system employed and suggest a significant role for relative prices and for the bequest motive in shaping saving decisions. We also find that expenditure decisions respond to both interest rates and anticipated inflation in a “Fisherian” fashion, but that the interest elasticity of saving is quite low and of uncertain sign. Our model also provides an estimate of the consumer's “horizon,” defined in the sense of Friedman.