The UK consumption function and structural instability: improving forecasting performance using a time-varying parameter approach

Haiyan Song, Peter Romilly, Xiaming Liu

Research output: Journal article publicationJournal articleAcademic researchpeer-review

17 Citations (Scopus)


Previous studies indicate that the poor forecasting performance of constant parameter UK consumption expenditure models is caused by structural instability in the underlying data generating process. Typically, this instability is removed by reparameterization within the constant parameter framework. An alternative modelling strategy is to allow some, or all, of the parameters to vary over time. A UK non-durable consumption expenditure model with time-varying parameters is developed, based on the permanent income hypothesis of Friedman (1957). This model takes into account temporal changes in the average and marginal propensities to consume. The variation in the parameter estimates is given an economic interpretation in terms of the influence of omitted variables, namely UK financial liberalization and expectational changes. The forecasting performance of this model is superior to that of two widely used constant parameter models. Further tests show that, even if these constant parameter models are respecified as time varying parameter models, the authors' model still retains a superior forecasting performance.
Original languageEnglish
Pages (from-to)975-983
Number of pages9
JournalApplied Economics
Issue number7
Publication statusPublished - 1 Jan 1998
Externally publishedYes

ASJC Scopus subject areas

  • Economics and Econometrics

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