What went wrong with the Hungarian consumption function? An econometric investigation of the time series aggregate consumption function for Hungary for 1960–1989

The paper focuses on the time series aggregate consumption function for the Hungarian economy. The empirical econometric analysis presented produces several new results. First, it shows that the income and consumption variables used in this type of model by previous studies are I(2) variables. Consequently, error correction models formulated in terms of their first differences are mis-specified. Second, it provides a strong empirical evidence supporting the view that consumption (and thus saving) was (real) interest rate elastic during the period under investigation, having impact both on the long run and on the short relationships between income and consumption. Third, it provides empirical evidence on choosing the proper income variable in the consumption function. The model selection results clearly supports the model with unadjusted total real money income variable. Fourth, it shows that for the period 1960–1986 a correctly specified and stable error correction model can be established. Finally, the analysis shows that when used for the period beyond 1986, this model suffers from a structural break.