FOREIGN TRADE UNIVERSITY

FACULTY OF INTERNATIONAL ECONOMICS

-----*-----

Econometrics 1 Mid-term report

Factors Influencing Private Consumption Expenditures

in Germany

Name of the student: Nguyen Ngoc Ha,

Tobias Schüler, Kim Thao Weil
Student ID: 2013450014,
2190101113, 2190101114
Supervisor: Vu Thuy Quynh

Hanoi, October, 2021

Individual Assessment Table
Evaluator Ha Tobias Kim
Ha - 10 10
Tobias 10 - 10
Kim 10 10 -
Average Score 10 10 10
Abstract
Household consumption has always been a factor that every country wants to
precisely measure in order to have a clearer picture of the economy. However, the
factors affecting a nation’s household consumption are not always unanimous among
researchers and economists, and those factors’ magnitude of effects on consumption
varies due to different theories.

This study aims at identifying the factors that may affect consumption, measuring the
effect of those factors towards consumption and giving the researchers’ outlook on
the econometric results. The paper uses the sample data of Germany’s household
consumption from 1970 to 2020, since countries with higher or lower level of income
usually give a clearer correlation between the determining factors than countries with
middle level of income. To identify these factors and specify a regression model, a
literature review was carried out and the OLS estimation technique applied to the
model.

The results imply a positive statistically significant impact of income and interest rate
on the private consumption expenditure in Germany. A rise of GNI by one billion
euros will be reflected by a rise of consumption of 0.273 billion euros and a rise of
one CPI point results in a consumption increase of 9.462. On the other hand, there is
no statistically significant influence of interest rate on consumption within the model,
however, taken individually, interest rates exert a negative impact on consumption
expenditure.

From these findings, the study suggests that policy makers should focus on income
and inflation rate when they want to increase the nominal wealth in a nation.
However, it is important to note that inflation rate has an inverse relationship with
real wealth. For business owners, the paper shows that raising wages can indirectly
affect consumption and lead to long-term revenue increases
 I. Table of Contents
II. List of Abbreviations 5
1. Introduction 6
2. Literature review 8
2.1 Underlying economic theories 8
2.2 Existing empirical studies 9
3. Model Specification 13
3.1 Methodology 13
3.2 Theoretical Model Specification 14
3.3 Sample Data 17
4. Estimation Results 21
4.1 Sample Regression Model 21
4.2 Hypotheses Testing 22
5. Conclusion and Outlook 28
5.1 Conclusion 28
5.2 Outlook 29
III. Bibliography 30
IV. Appendix 34
V. Declaration 37

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 II. List of Abbreviations
CPI – Consumer Price Index
ECM – Error Correction Mechanism
FRED – Federal Reserve Economic Data
GNI – Gross National Income
OECD – Organization for Economic Cooperation and Development
OLS – Ordinary Least Squares
PFCE – Private final consumption expenditure
R² - Coefficient of Determination

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 1. Introduction
Consumption has always been an important factor to determine a country’s economic
development. However, identifying the components that affect the consumption
expenditures of a nation’s households is challenging. There are several reasons to
this.

Firstly, the factors affecting consumption are still up for debate. Researchers and
scientists have been bringing up theories, models and functions to pinpoint the
relation between different variables and consumption. However, each person has his
or her own perspective on the main factors affecting a country’s consumption volume.
For example, John Maynard Keynes asserted that there are numerous factors affecting
consumption expenditure, among which income is the one dominant (Keynes, 2018,
p. 209 ff.) Afterwards, Franco Modigliani and Richard Brumberg improved Keynes’
theory and developed the Life-Cycle Hypothesis, which states that individuals plan
their spending for their entire lifetime, taking into account future income (Hayes,
2021). Additionally, the Nobel-Prize-winning economist Milton Friedman
established the Permanent Income Hypotheses, saying that people will spend
consistently with their expected long-term average income, implying that changes in
consumers’ behavior is unpredictable due to their various individual expectations
(Kagan, 2020).

Secondly, even after determining the important factors that have an impact on the
consumption within a country, the magnitude of each factor is still difficult to
identify.

This paper aims at providing insight into the relationship between three major factors
and private consumption expenditure of a country. These factors are national income
(measured by GNI), inflation (measured by CPI) and interest rate (measured by 10-
year government bond yields). The factors will be explained in more detail
throughout the work. To test the hypotheses, the OLS (Ordinary Least Square)
regression will be applied, with the assumption that all the requirements are satisfied
and there are no externalities. The analysis is performed for the case of Germany with
51 observations, each observation represents a year from 1970 to 2020.

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In this paper, Germany has been selected to investigate the factors that influence the
consumption expenditures due to the high-income nature of the nation, as high-
income countries show a stronger connection between earnings and consumption
compared to middle-income countries (Diacona & Maha, 2015, p. 1535).

The paper will start with an outline of previous research and theories. Based on this
review, the relevant hypotheses will be developed. Then, the applied methodology
will be explained, including the model specification, data extraction as well as data
and variable analysis. To test the developed hypotheses, the OLS estimation
technique will be used on the specified model. Further, multiple hypotheses tests will
be used. To sum up the research, a conclusion will be drawn, and an outlook given at
the end.

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 2. Literature review
2.1 Underlying economic theories
Income is defined as payments received plus the changes in the value of assets in a
specified time period (Raupp & Raupp, 2018, p. 156), while consumption is the
expenditure on goods and services by households (Carroll, 2016). According to
Keynes’ consumption function (Kenton, 2020), the consumption and income are
arranged in a linear relationship, which suggests that aggregate consumption is
entirely dependent on earnings, more specifically, disposable income, assuming that
the autonomous income is constant. Keynes assumes that the function is fairly stable
over time, partly based on the Psychological Law of Consumption. Moreover, this
concept states that increased income raises the average consumption spending,
however, not to the same extent (Ali & Rahman, 2015, p. 15).

Furthermore, the Keynes´ consumption function can be extended by his findings on

the relationship between spending, output and inflation, stated in the IS-LM curve.
One main part of Keynes´ theory is that whenever inflation is high, for example
through an increase in money supply, the supply of money exceeds the money
demand. This would lead to a fall of interest rates which on the other hand would
reduce the incentives for savings in an economy and thereby encourage consumption.
Thus, Keynes states in his theory that inflation has a positive impact in consumption
(Krugman & Wellls, 2018, p. 640 ff.)

In addition to that, Keynes stated that a negative relationship between interest rates
and private consumption expenditures exists. This indicates that with a higher interest
rate, the household spending decreases due to the substitution effect. Moreover, this
implies that consumers prefer to save and defer immediate consumption over direct
expenditure when more return is expected on savings due to higher interest rates
(Keynes, 2018, p. 97 ff.).

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 2.2 Existing empirical studies
The Keynes´ function, despite having been “reformed” many times by economists for
the past 100 years, be it Life-cycle Hypotheses, Relative Income Functions or
Permanent Income Functions, retains its core value: it implies the positive
relationship between income and consumption in a certain period of time. This is
what the paper focuses on, and it has been supported by previous research numerous
times. According to a cross-sectional data analysis by Ali-ud-din Khan (Khan, 2014),
income has a positive relationship with consumption following the function:

C = 2401.027 + 0.832Y

With C being consumption, Y is the income. The parameter shows that with every 1
unit increase in income, consumption goes up by 0.832. The F-test gave a result of
96.465, implying the great significance of the model (Khan, 2014, p. 5).

Another research done on the Chinese urban resident income levels from 2002 to
2012 using the cluster analysis shows the same pattern (Fangfang Hou, 2015, p. 251
ff.). However, at different income levels, the coefficients are different, showing a
more in-depth implication of the theory. Furthermore, the marginal propensity to
consume decreases as income raises.

In 2018, research was done in Shangcha, China. They applied the Irrational
Keynesian Consumption function and Irrational Life-Cycle Consumption Function
Model (Yan & Liting, 2018, p. 1517 ff.). They have gathered statistics from two
different areas: rural and urban. In this research, they have also recognized a
significant dependence of consumption on income.

A research that was done with a similar model to this work was done in Nigeria
(Onanuga, et al., 2015). They have built a similar consumption function based on
Keynes’ and used OLS method and error correction mechanism (ECM) technique to
estimate the model. The goodness of fit was 0.85, showing high credibility of the
model. Moreover, the coefficient of income stood at positive 0.64, demonstrating a
positive relationship between income and consumption. The result is close to
previous research done in the same country, which result was 0.67. The difference in

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parameter was due to the difference in time period, according to their speculation.
The relationship was also proved to be non-proportional, which contradicts Keynes’
belief that consumption is reversible if income decreases. This means that if income
rises, so does consumption; but when income falls, consumption does not decrease
accordingly (Onanuga, et al., 2015, p. 12)

Further, this work will analyze the impact of inflation rate on consumer expenditure
in Germany. Previous research implies a positive relationship between inflation and
customer spending. Obinna (2020) has analyzed the impact of inflation on household
consumption expenditure in Nigeria from 1981 to 2018. Using the OLS estimation
technique and data from the Central Bank of Nigeria, evidence was given that
households spend more money on goods and services during high inflationary periods
than in periods with lower inflation. The estimation of the model led to a small
positive influence of inflation on consumption expenditure with a coefficient of
0.1124 (Obinna, 2020, p. 109 f.).

The findings of Obinna (2020) are supported by Effah Nyamekye and Adusei Poku
(2017). The empirical study observes the impact of inflation on consumer spending
based on data from Ghana for the period 1964 to 2013. After performing an OLS
estimation, it was concluded that inflation exerts a positive impact on consumer
spending in Ghana. The results demonstrate that a 1.00% increase in inflation leads
to a 19.20% increase in consumer spending (Effah Nyamekye & Adusei Poku, 2017,
p. 5).

De Mello and Carneiro (2000) analyzed the consumption behavior during high
inflation in the Latin American countries Venezuela, Peru, Argentina, Brazil,
Paraguay and Uruguay. Similar to the previously mentioned studies, the OLS
estimation method was applied. The research supports the findings that inflation
positively affects consumption (de Mello & Carneiro, 2020, p. 241). The results
demonstrate that the presence of persistently high inflation results in volatility in
consumption expenditure (de Mello & Carneiro, 2020, p. 243). The increase of
consumption during high inflation periods is reasoned with the differences between
perceived and observed income (de Mello & Carneiro, 2020, p. 239).

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Additionally, the effect of interest rates on German private consumption spending
will be examined in this paper. In several researches and studies a negative
relationship between interest rates and consumer expenditures has been indicated.
Hence, an increase in interest rates is predicted to result in lower consumption which
Keynes states to be true (Keynes, 2018, p. 98).

Frederic Mishkin supports this theory that tight monetary policy, which raises interest
rates in a country is contributing to a decrease in consumer purchases and thus states
that interest has a negative impact on expenditures (Mishkin, 1976, p. 652). This
asymmetry between interest rates and consumption has been investigated for a case
in South Africa for the period 2000 to 2018 using data from the Statistics South Africa
and the South African Reserve Bank (Fikizolo, 2020, p. 19). By using the OLS
estimation and Vector Autoregressive approach in this study, it was proven that a
negative relationship between interest rate changes and final consumption exists
(Fikizolo, 2020, p. 20 ff.). The results of the model estimation through economic and
econometric tools reveal that an increase of 1.00% in the interest rate has led to a
reduction of around 0.60% in private consumption expenditure. Simultaneously, a
1.00% decrease in the interest rate caused a rise in consumption by approximately
0.56% (Fikizolo, 2020, p. 40).

The results of this study are further validated by Kapoor and Ravi (2009), who
examined the causal effect of a higher interest rate on household consumption
expenditure by utilizing an Indian banking legislation and investigating detailed data
of the National Sample Survey from 2000-2001 and 2005-2006 (Kapoor & Ravi,
2009, p. 2 f.). Applying the OLS estimation method and regression discontinuity
approach to evaluate the effects (Kapoor & Ravi, 2009, p. 12 ff.), the main result
demonstrates that an increase of 50 basis points (0.50%) in the interest rate leads to
an immediate decrease of 12.00% in consumption spending. This indicates the
existence of immediate substitution of consumer expenditure when interest rates
increase (Kapoor & Ravi, 2009, p. 20 f.).

Furthermore, an empirical work determines the factors influencing private

consumption in Lesotho from 1982 to 2013 using economic data from the Central

11
Bank of Lesotho, the Ministry of Finance and Bureaus of Statistics (Sekantsi, 2016,
p. 66). This study presents evidence that higher interest rates reduce private spending
(Sekantsi, 2016, p. 58). An error correction model was assessed by using the
Autoregressive Distributed Lag approach to cointegration as well as other
instrumental variables like the OLS were used (Sekantsi, 2016, p. 63 f.). This paper
confirms the previous results that higher interest rates negatively affect consumer
spending. Moreover, the reduction in consumption due to higher interest rates is
reasoned by the substitution effect. Hence people defer their consumption when
opportunity cost of immediate spending is higher (Sekantsi, 2016, p. 71).

After analyzing previous research and theories the following hypotheses are stated
regarding the relationship between the independent variables and private
consumption expenditure in Germany and will be tested in this paper:

(I) Income has a positive impact on private consumption expenditure.

(II) Inflation exerts a positive influence on private consumption expenditure.
(III) Interest rate negatively impacts private consumption expenditure.

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 3. Model Specification
3.1 Methodology
The method used to estimate the model in this paper is the Ordinary Least Square
approach. This is a type of linear least squares method to estimate unknown
parameters of a linear regression model. Here, the estimates minimize the sum of
squared residuals. The OLS is built based on 6 assumptions:

1. The regression model is linear in the parameters

2. The population mean of disturbances is 0
3. The disturbance is homoscedastic
4. There are no correlations between disturbances
5. The model is correctly specified
6. All independent variables are uncorrelated with the disturbances

When all of the conditions above are met, the OLS estimators is considered BLUE
(Best Linear Unbiased Efficient) according to Gauss-Markov theorem (Gujarati &
Porter, 2009, p. 92).

With the application of the OLS model it will be able to derive unbiasedness,
consistency, and other important statistical properties efficiently. The model proved
to be successful with high goodness of fit and relatively similar estimators between
consecutive tries within the same region.

In this work, the OLS method will be applied on a linear regression model. This will
be specified based on the previously outlined theories and research. The following
chapter will describe the process of model specification, data collection and the
analysis of relationships between the independent variables in detail.

To extract data, the authors relied on acknowledged sources such as the Federal
Statistical Office. The model will then be estimated using Stata. Focus of this
estimation will be the determination of the regression coefficients and coefficient of
determination. Additionally, with the usage of the t-test and F-test, the statistical
significance of the independent variables will be tested.

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 3.2 Theoretical Model Specification
One of the most popular models has been established by John Maynard Keynes who
investigated the influence of income on consumption.

𝐶 =𝐴+𝑀∗𝐷
Where:
C: Consumption M: Marginal Propensity to Consume
A: Autogenous income D: Disposable income

From this a more detailed model is derived to represent the impact of different factors
on consumption. The linear regression model in this paper contains three independent
variables, income, interest rate and inflation, which are the factors influencing the
dependent variable of consumption spending. The stochastic disturbance term u
represents the variables that are not involved in the model but might affect the
dependent variable (Gujarati & Porter, 2009, p. 62). This error term includes non-
observable factors that are not further specified or the regarding data is not available
but still have an effect. Hence, the expected future income as well as the consumption
preferences are not further assessed in this work, despite having an evidenced effect
on private spending (Jappelli & Pistaferri, 2010, p. 480 f.).

In this paper, the income in Germany is described by the Gross National Income
(GNI), the interest rate is the long-term interest rate, and the inflation is illustrated by
the Consumer Price Index (CPI) of all items and the consumption spending by the
private final consumption expenditures.

Hence, the following population regression model can be established:

𝐶𝑜𝑛𝑠𝑢𝑚𝑝𝑡𝑖𝑜𝑛 = 0 + 1 ∗ 𝐺𝑁𝐼 + 2 ∗ 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑟𝑎𝑡𝑒 + 3 ∗ 𝐼𝑛𝑓𝑙𝑎𝑡𝑖𝑜𝑛 + 𝑢𝑖

Where:

0 : intercept term 3 : regression coefficient of Inflation

1 : regression coefficient of GNI 𝑢𝑖 : error term

2 : regression coefficient of Interest rate

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For the sample data collected, the following sample regression model is developed:

̂
𝐶𝑜𝑛𝑠𝑢𝑚𝑝𝑡𝑖𝑜𝑛 = ̂ 0 + ̂ 1 ∗ 𝐺𝑁𝐼 + ̂ 2 ∗ 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑟𝑎𝑡𝑒 + ̂ 3 ∗ 𝐼𝑛𝑓𝑙𝑎𝑡𝑖𝑜𝑛

The corresponding stochastic form of the sample regression model is concluded:

𝐶𝑜𝑛𝑠𝑢𝑚𝑝𝑡𝑖𝑜𝑛 = ̂ 0 + ̂ 1 ∗ 𝐺𝑁𝐼 + ̂ 2 ∗ 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑟𝑎𝑡𝑒 + ̂ 3 ∗ 𝐼𝑛𝑓𝑙𝑎𝑡𝑖𝑜𝑛 + 𝑢̂𝑖

Where:

̂ 0 : estimator of 0 ̂ 3 : estimator of 3

̂ 1 : estimator of 1 𝑢̂𝑖 : estimator of 𝑢𝑖

̂ 2 : estimator of 2

The dependent variable of the specified model is the consumption expenditure in

Germany. To measure consumption expenditure the private final consumption
expenditure (PFCE) is used. This measurement includes all the consumption
expenditures of households and non-profit organization serving households on new
durable and non-durable goods (excluding land) as well as on services. Additionally,
household consumption includes the rent of owner-occupied housing and own-
account production. On the other hand, expenditure of non-profit organizations
accounts for the value of goods and services for own use (Implementation, n.d.). In
the sample, consumption expenditures are measured annually in billion euros.

For the independent variable income, the proxy GNI is used. The GNI measures the
value of goods and services produced by the residents of a country. It is calculated as
the gross domestic product added with the net receipts from abroad of compensation
of employees, property income and net taxes deducted by subsidies on production
(OECD, n.d.). For the purpose of this work, the GNI is seen as superior proxy
compared to the GDP. GNI measures the income of the residents of a country. This
income is likely to be spent within this country and thereby affecting consumption.
GDP measures the value of the production of a country which might generate income
abroad. Throughout this work, GNI will be displayed in billion euros.

To measure the long-term interest rates, yields of 10-year government bonds are used.
The interest rates imply rates that bonds are currently traded, not the rates at which

15
the bonds have been issued. Thus, the current market interest rates are reflected.
Long-term interest rates of government bonds encourage either savings or
consumption and are therefore well fitted for the model. The interest rates will be
displayed in percentage (OECD, 2021).

The proxy for the inflation is the Consumer Price Index. The CPI measures the price
increases of a defined basket of goods and services representing the goods and
services purchased by households in the country (Federal Statistical Office, n.d.). The
CPI will be shown in points using the year 2015 as basis where the CPI equals 100
points.

Consumer expenditure is the dependent variable of the applied model. As described

in the outlined studies and the theoretical background of Keynes, income, interest rate
and inflation are independent variables affecting consumption expenditure. However,
the independent variables impact each other as well. Higher interest rates lead to
weaker economic growth and thus slower inflation and vice versa. Low inflation
signals a slow economic growth. The decision makers of monetary policy would aim
at lowering the interest rates to lower the cost of borrowing and foster economic
growth. During high inflation phases, interest rates will be raised to slow economic
growth and inflation (McArdie, 2014, p. 2 f.). Additionally, research of the Federal
Reserve Bank of St. Louis has provided evidence that inflation positively impacts
income. The study has shown that if inflation increases, nominal wage growth also
rises (Sanchez, 2015). A well-known model explaining the relationship between
interest rates and income is the IS-LM model of Keynes. Assuming that a country is
closed to international trade, a fall in interest rates, for example through an increase
in money supply, will cause the economy to purchase assets leading to an increase in
output, income and employment of an economy to increase. Interest rates would fall
and income increases until money demand and money supply are in an equilibrium
(Krugman & Wellls, 2018, p. 640 ff.). However, there are no recent empirical studies
supporting this relationship between income and interest rates.

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 3.3 Sample Data
To estimate the population parameters a credible sample model must be created which
involves obtaining reliable data from valid sources. Thus, in this paper the data
regarding the variables have been extracted from reputable websites. Information
about consumption expenditure and CPI in Germany have been attained from the
Federal Reserve Bank of St. Louis (FRED). This online database consists of
numerous economic data time series from several public and private, international as
well as national sources. On FRED, the user is provided tools to comprehend and
interact with the displayed data in multiple ways (FRED, n.d.).

One major original source that FRED uses to illustrate data in meaningful graphs is
the Organization for Economic Co-operation and Development (OECD). This
international organization works collaboratively with governments, policy authorities
and the public and provides a collection of knowledge, data and analysis as well as
advice for public policy decisions (OECD, n.d.).

The data of the dependent variable PCFE in Germany has been reported by the OECD
and retrieved from FRED. Here, the displayed frequency is in quarters starting in
1970 Q1 and the currency units are in Euros (FRED, 2021).

The GNI which represents the income generated by residents in Germany is retrieved
from the Federal Statistical Office Destatis, which published the national accounts
data from 1925 to 2020 in August 2021 (Destatis, 2021). This organization provides
neutral and professional statistics regarding economic, environmental or public issues
in order to display past and present data for decision-making and detailed
comprehension of information (Destatis, n.d.).

Next, the CPI of all items in Germany which is also reported quarterly since 1960 Q1
by the OECD was obtained from FRED (FRED, 2021).

As the last independent variable, information regarding the interest rates in Germany
were acquired from OECD data which illustrates the long-term interest rates starting
in 1953 (Federal Statistical Office, n.d.).

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In this work, a sample model using 51 observations for each variable is developed in
order to display a reliable time period of 51 years with data corresponding for each
year since 1970 until 2020 (Appendix 1).

To summarize and organize the characteristics of this dataset effectively, the adjusted
data has been inserted into Stata-64 to assess the sample statistics for each variable in
detail (Appendix 2).

For the dependent variable private consumption expenditure, the sum aggregates to
50,525.643€ billion and a mean of 990.699€ billion has been calculated which
represents the average of the consumption spending during this period. The arithmetic
mean reveals the center of the data where outliers have less effect on the central
tendency and hence the expected value of a variable (Wooldridge, 2012, p. 704). The
minimum of the sample data amounts to 222.369€ billion which is the first
observation in 1970. Consequently, the lowest consumption spending was in the
initial year, and the following years all record a larger expenditure. The greatest value
of consumption has been recorded in 2019 with 1,808.710€ billion which is almost
double the average mean. The standard deviation of this data amounts to 470.081€
billion which indicates a relatively large spread around the mean because it is affected
by outliers.

Secondly, the independent variable GNI has been analyzed and a total of 90,698.028€
billion has been recorded from 1970 to 2020 which results in a mean of 1,778.393€
billion. Additionally, this calculated average income in Germany has been affected
by the minimum amount of 261.540€ billion in the first observed year and the
maximum of 3,585.963€ billion in 2019 which represent the most significant outliers
in this dataset. The permanent increase in GNI suggests that income in Germany has
grown during the period, however in 2020 a small decrease of 124.678€ billion has
been reported. This small decline in the GNI can be reasoned by the COVID-19
pandemic, which affected the economy globally. Furthermore, the spread indicated
by a 962.561€ billion standard deviation around the mean implies that the values vary
notably throughout these years.

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The inflation which is expressed by the CPI reflects the price levels in each year
according to a basis year with a CPI of 100 points for comparison. In the specified
period the average value for this independent variable equals 71.756 points which is
comparably low to the basis year 2015, however implies that the price level was lower
than the basis year on average. In 1970, 29.966 points present the minimum of the
CPI while the maximum of 107.751 has been reported in 2019. Consequently, a
steady rise in this data can be observed with a small decrease in the last year 2020.
The standard deviation of 22.483 points in this sample presents the statistical
dispersion considering the range of the CPI.

The last independent variable in this model is the interest rate which is measured in
percent. Here, the average value amounts to 5.395% in these 51 years in Germany.
Further, the minimum in the interest rate of -0.511% in 2020 and the maximum of
10.442% in 1974 have been recorded. Hence, the data varies considerably throughout
this period in a range of 10.953%. Additionally, the sample demonstrates that the
interest rate has decreased continuously over the years with minor interruptions. The
standard deviation of 2.9589 reveals a concentration of the values around the average
interest rates

In order to illustrate the correlation between different variables, a correlation matrix

can be developed containing the correlation coefficients between the variables. Here,
the aim is to summarize the data from the sample dataset and present the significance
of the association for the factors influencing the consumption (Jöreskog, 1978, p. 443
f.). Hence, a symmetric 4x4 matrix presenting the four variables in the model with
the calculated correlation coefficients using the sample gathered sample data is
created in Excel.

Here, the high correlation between the independent variables and the dependent
variable consumption indicates the existent possibility of a causal relationship,
however, the correlation coefficient alone is not a sufficient condition to conclude a
correct connection (Aldrich, 1995, p. 375). Furthermore, as specified in previous
research, a positive relationship between income and the consumption expenditure as
well as the inflation is expected which can be assessed by the corresponding high

19
correlation coefficients of 0.9964 and 0.9952 between GNI and consumption and CPI
and consumption. At the same time, the high negative coefficient of -0.9130 between
the interest rate and consumption suggest an inverse relationship between the
variables which is also supported by prior theories. Consequently, the causal
relationship between the variables requires further analysis and estimation in order to
investigate the impact of the independent variables on the dependent variable.

There is no perfect correlation between the independent variables GNI, CPI and
interest and hence, no multicollinearity exists which means, that the OLS estimation
method can be used to predict the population parameters.

Consumption GNI CPI Interest

Consumption 1.0000
GNI 0.9964 1.0000
CPI 0.9952 0.9859 1.0000
Interest -0.9130 -0.9262 -0.8945 1.0000

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 4. Estimation Results
4.1 Sample Regression Model
In this work, the obtained data regarding the private consumption expenditure, the
interest rate as well as the inflation have been imported into Stata-64 in order to
establish the sample regression model. The program provides a software package to
analyze and manipulate data for reports and statistical investigation (Stata, n.d.).

As a result, the estimated model for the sample data based on the estimation output
from Stata has been obtained (Appendix 3):

𝐶 = −182.811 + 0.273 ∗ 𝐺𝑁𝐼𝑖 + 1.595 ∗ 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡𝑖 + 9.462 ∗ 𝐶𝑃𝐼𝑖 + 𝑢̂𝑖

For this sample data of 51 observations, the estimated model has been established by
regressing the independent variables on the dependent variable. Here, the intercept
term amounts to -182.81 which represents the expected mean value of Y when all of
the variables in the model equal to zero. However, in reality, this is never the case, as
there is no event that inflation will be non-existent. And even though there is a
theoretical probability, that income in a country will vanish, in the sample data no
observation of GNI or CPI with values of zero are recorded. Hence, the negative
number of the intercept does not have an intrinsic meaning and no practical
interpretation is possible (Gujarati & Porter, 2009, p. 102).

The regression coefficient of the income implies that, when income in Germany
increases by one billion euros, the final consumption expenditure will increase by
0.273 billion when other variables remain constant. Consequently, a positive
relationship between this independent variable and the consumption is observable.

Next, the positive number of 1.595 suggests that the regression coefficient of the
interest rate contradicts with the previous research which provided evidence for a
negative relationship between the interest rate and private consumption. In this
estimated model, the sample data jointly demonstrate that an increase in interest rates
by one unit, hence 1.00% will increase household spending by 1.595 bullion euros.
Consequently, this relationship requires further analysis and evaluation in order to
understand the causal relationship of this independent variable with the consumption.

21
Due to the fact, that it is not sufficient to solely consider the sample data and the final
estimated model, the individual effects must be investigated as well with help of
testing relevant hypotheses.

Lastly, the regression coefficient of the inflation is estimated to be 9.462. This means
that an increase in the inflation by one CPI point is estimated to result in a rise in
consumption of 9.462 billion euros, when the other independent variables are
unchanged.

The estimated model has a coefficient of determination (R²) of 0.9988 which is very
close to 1 and implies that 99.88% of the variance in the dependent variable can be
explained by the model (Greene, 2018, p. 85).

4.2 Hypotheses Testing

To test the previously developed hypotheses, the estimation output from Stata-64 has
been assessed and the process of testing the significance of the regression coefficients
of the independent variables has been executed. Initially, the estimated model has
been investigated in order to confirm the results with the findings of existing theories
or to determine differences which require further evaluation.

At first the overall significance of the explanatory variables is tested which helps to
determine whether the independent variables in the model have an effect on the
dependent variable (Wooldridge, 2012, p. 180). Consequently, the following
hypotheses are established:

𝐻0 : 𝛽𝐺𝑁𝐼 = 𝛽𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 = 𝛽𝐶𝑃𝐼 = 0

2 2 2
𝐻1 : 𝛽𝐺𝑁𝐼 + 𝛽𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 + 𝛽𝐶𝑃𝐼 ≠0

The significance level is set to 5% and the p-value approach is used to find evidence
that any of the independent variables helps to explain the dependent variable and
hence to reject the null hypothesis. With the results from Stata, the p-value for the
estimated model amounts to 0.000 (Appendix 3). Consequently, the p-value of the
joint significance of the regression is smaller than the significance level  and the
null hypotheses can be rejected for this sample. Thus, the variables are jointly

22
significant and explain for some variance in the dependent variable at a 5% level of
significance. This level indicates the probability of rejecting the H0 despite it being
true (Studenmund, 2016, p. 126 f.)

To determine the individual impact of the variables, the p-value has been investigated
in order to assess the significance of GNI, interest rate and inflation on the
consumption level in Germany. Here, the estimation output of the estimated model
instantly displays the p-values for the individual regression coefficients which are
significantly low for the GNI as well as for the inflation since they measure 0.000
which is below a significance level of either 5% or 1%. However, at the same time
the interest rate presents a p-value of 0.486 which causes the question, whether this
independent variable has a significant effect on the consumption expenditure and
requires further analysis and testing since in this model the interest rate has no
significant impact.

At first the regression coefficient of the GNI is investigated and an expected positive
relationship considered due to the fact that previous research assumes income as the
main influence on private spending. Hence, the related hypotheses are developed to
test for the effect of GNI on consumption:

𝐻0 : 𝛽𝐺𝑁𝐼 ≤ 0
𝐻1 : 𝛽𝐺𝑁𝐼 > 0
Here, the null hypothesis states that there is either no or a negative relationship
between the independent variable and the dependent variable, and significance level
is set to 5% in order to evaluate the relevance. Considering the estimation output from
Stata for the regression between the GNI and the consumption, the p-value of the
associated with the observed value of t (14.63) measures 0.000 which is below the
significance level of  at 5% (Appendix 4). Additionally, the estimated GNI has the
same sign as in the H1. As a result, the null hypothesis that this regression coefficient
has no or a negative impact on the dependent variable can be rejected in this sample.

As stated before, during the testing for the overall significance, the interest rate has
led to the concern, whether it has a substantial effect on the dependent variable, since
the p-value was at for a two-tailed test 0.486 and a p-value of 0.243 for a one-tailed

23
test. This is above the significance level of 5%. Additionally, the positive regression
coefficient Interest of 1.595 implies a positive relationship between the interest rate
and the consumption expenditure. For this reason, the individual influence must be
assessed, and the significance tested at a 5% significance level with the subsequent
hypotheses:

𝐻0 : 𝛽𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 ≥ 0
𝐻1 : 𝛽𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 < 0
To derive the p-value for the individual regression coefficient, the Stata-64 output has
been analyzed after regressing the consumption expenditure and the interest rate
independently. Here, the regression coefficient measures -145.049 and the
corresponding p-value is 0.000 (Appendix 5). Following from this, the null
hypothesis can be rejected and despite the previous result implying that interest rate
has a non-significant relationship on the consumption, the sample data reveals, that
individually, the interest rate has a significant effect on private spending at a 5% level
of significance. Nevertheless, the joint significance must be investigated in order to
identify whether the interest rate should be excluded from the model in connection
with the other variables.

The last independent variable inflation is presumed to have a positive impact on the
consumption in Germany which means, that an increase in the CPI will lead to a
larger private spending. Accordingly, the two hypotheses have been constituted in
order to examine this argument:

𝐻0 : 𝛽𝐶𝑃𝐼 ≤ 0
𝐻1 : 𝛽𝐶𝑃𝐼 > 0
At a level of significance of 5%, the p-value is evaluated and demonstrates, that for
the inflation, the p-value of 0.000 is below the level of significance of  (Appendix
6). Hence, the H0 can be rejected in this sample and a positive relationship between
the inflation and consumption is supported from the data.

Since the estimation output from Stata-64 has implied that the interest rate has a
positive impact on the consumption spending in Germany and indicated among the

24
testing for the overall significance that the significance of the interest rate in the
estimated model is inconsiderable, the joint effect on the dependent variable is tested.
Moreover, interest rate together with GNI as well as with the inflation is investigated
in pairs to determine whether the independent variable has a joint impact on the
consumption expenditure.

At first, the combination of the GNI and the interest rate is analyzed by executing a
F-test for the restricted and unrestricted models at a 5% level of significance (Brooks,
2014, p. 170).

The unrestricted model involves the three independent variables:

𝐶 = 𝛽0 + 𝛽𝐺𝑁𝐼 ∗ 𝐺𝑁𝐼𝑖 + 𝛽𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 ∗ 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑖 + 𝛽𝐶𝑃𝐼 ∗ 𝐶𝑃𝐼𝑖 + 𝑢𝑖

While the restricted model only involves the left variable CPI:

𝐶 = 𝛽0 + 𝛽𝐶𝑃𝐼 ∗ 𝐶𝑃𝐼𝑖 + 𝑢𝑖

The corresponding hypotheses to test whether the two variables jointly have an effect
on the consumption is developed:

𝐻0 : 𝛽𝐺𝑁𝐼 = 𝛽𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 = 0
𝐻1 : 𝛽²𝐺𝑁𝐼 + 𝛽²𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 > 0

The test statistic Fs is calculated by (Gujarati & Porter, 2009, p. 272; Appendix 6):

(𝑅²𝑢 − 𝑅2 𝑅 ) ∗ (𝑛 − 𝑘 − 1) (0.9988 − 0.9905) ∗ (47)

𝐹𝑠 = = = 162.542
(1 − 𝑅 2 𝑢 ) ∗ 𝑚 (1 − 0.9988) ∗ 2

Where:
𝑅²𝑢 : coefficient of determination of the unrestricted model
𝑅²𝑟 : coefficient of determination of the restricted model
𝑘: number of independent variables in the unrestricted model
𝑚: number of linear restrictions in H0

The critical value F is derived from Excel using the formula (Microsoft, n.d.):

= 𝐹. 𝐼𝑁𝑉. 𝑅𝑇(, 𝑚, 𝑛 − 𝑘 − 1)

25
and leads to a F value of 3.195. Hence, the test statistic Fs is larger than the critical
value F which results in the rejection of the null hypothesis. Moreover, the
independent variables GNI and interest rate are jointly significant with a level of
significance of 5% for this model.

Additionally, the joint effect of the interest rate together with the inflation rate is
investigated in order to conclude whether the combination of the independent
variables is substantial. To test for this, similar hypotheses are established to test for
the significance at a 5% level:

𝐻0 : 𝛽𝐶𝑃𝐼 = 𝛽𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 = 0
𝐻0 : 𝛽²𝐶𝑃𝐼 = 𝛽²𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 > 0
Here, the unrestricted model remains as the one before, but the restricted model
adjusts to:

𝐶𝑜𝑛𝑠𝑢𝑚𝑝𝑡𝑖𝑜𝑛 = 𝛽0 + 𝛽𝐺𝑁𝐼 ∗ 𝐺𝑁𝐼𝑖 + 𝑢𝑖

To test the joint effect on the dependent variable, the inflation and interest rate are
omitted in this restricted model. Hence, the test statistic is calculated using the same
formula as before but adjusting the value of the restricted R² (Appendix 4):

(0.9988 − 0.9928) ∗ (47)

= 117.5
(1 − 0.9988) ∗ 2

Furthermore, the critical value F measures 3.195 once again, since the number of
restrictions as well as the level of significance have not been changed. Thus, the test
statistic is larger than the critical value of F and the null hypothesis can be rejected.
Thereby, it is evident, that the joint effect of the interest rate and the inflation are
considerable at a 5% level of significance.

To conclude, the results demonstrate, that the interest rate individually has a
significant effect on the consumption expenditure in Germany as well as a joint effect
with either the GNI or the inflation. Due to this precise examination, the result
confirms the findings of previous research and support the fact that with a higher
interest rate, the consumption spending decreases and vice versa. However, the
relationship in the estimated model between this independent variable and the

26
dependent variable becomes positive with a regression coefficient of 1.595 which
causes the impact of interest together with the GNI and the inflation to become
insignificant. This particular finding can also be supported by previous research of
Hansen (1996) which explains that the interest rate has a negative impact on the
consumption expenditure in a country. However, in conjunction with the income, the
substitution effect, that people defer present consumption to a future date with higher
interest rates, diminishes with increasing income (Hansen, 1996, p. 68).
Consequently, the result of this work presents the impact of the interest rate in theory
decreases the consumption spending in Germany, however this negative effect
becomes less critical in the estimated model. Hence, in this model, the interest rate
becomes less significant despite the fact that it individually has a strong effect on the
dependent variable.

27
 5. Conclusion and Outlook
5.1 Conclusion
Consumption within an economy is driven by multiple factors. Keynes´ theories and
recent research suggest that the most important variables impacting consumption
expenditure are income, inflation and interest rates. This work has dealt with the
impact of these independent variables on the dependent variable private consumption
expenditure in Germany from 1970 to 2020.

To determine this influence the OLS estimation method was applied on the defined
linear regression model. The results show that income and inflation both have a
significant and positive impact on consumption at 5% level of significance. The
findings suggest that whenever GNI increases by one billion euros, other variables
held constant, consumption expenditure increases by 0.272 billion euros. Further,
whenever the CPI increases by one point, other variables held constant, private
consumption spending increases by 9.462 billion euros. Thus, the hypotheses that
income and inflation exert a positive impact on consumption have been validated.
The analysis of R² indicates that there is a high goodness of fit in the model since the
independent variables explain for 99.88% of the variance in the dependent variable.

Because interest rate has no significant impact within the model, its individual impact
as well as the joint impact with inflation and income has been tested. Evidence was
given that interest rate significantly influences consumption at 5% level of
significance individually as well as jointly with one of the other independent
variables. However, since there is no significant influence within the model, there is
not enough evidence to support the hypothesis that interest rates exert a significant
negative impact on inflation.

28
 5.2 Outlook
The outlined results are important to consider for political decision makers, especially
with regard to fiscal and monetary policy. One of the main aims of politicians should
be ensuring wealth among the population which can be measured using consumption
expenditure as this is the amount spend on goods and services for private use. This
work has demonstrated that, when trying to impact consumption expenditure,
changes in income and inflation play a significant role while the focus on interest
rates can be limited. Driving up income and inflation can foster consumption
expenditure and thereby increase wealth in the society. However, it is important to
understand that whenever inflation increases it reduces the value of money and thus
real wealth would not increase.

The findings further provide valuable insights for businesses. Since businesses are
the main profiteers of increases in consumption, it should be their aim to increase
income to exert a positive impact on the consumption expenditure in the economy.
One way of increasing income can be the increase of wages within the whole
population. Which leads to higher labor costs in the short run can result in higher
income in the future.

29
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 IV. Appendix
1. Sample Data Table

Observation Year Private Consumption GNI CPI Interest

1 1970 222.369 361.640 29.966 8.317
2 1971 247.506 400.840 31.662 7.992
3 1972 272.927 436.620 33.641 7.875
4 1973 301.936 486.230 36.098 9.308
5 1974 325.684 526.250 38.425 10.442
6 1975 356.151 552.020 40.513 8.675
7 1976 383.565 598.990 42.013 8.033
8 1977 411.845 637.220 43.470 6.533
9 1978 435.889 682.100 44.557 6.133
10 1979 475.615 738.610 46.928 7.567
11 1980 514.317 789.980 49.342 8.425
12 1981 544.659 825.900 52.864 10.133
13 1982 565.866 859.560 55.322 8.908
14 1983 591.766 900.400 56.822 8.083
15 1984 618.907 947.930 57.996 7.958
16 1985 641.003 990.680 58.910 7.042
17 1986 658.360 1,041.190 58.366 6.158
18 1987 680.251 1,067.750 58.932 6.250
19 1988 709.750 1,131.660 59.932 6.492
20 1989 761.914 1,211.110 61.737 7.025
21 1990 818.406 1,317.940 63.607 8.727
22 1991 889.928 1,601.392 67.108 8.446
23 1992 952.405 1,717.115 69.347 7.835
24 1993 992.009 1,762.243 72.332 6.496
25 1994 1,026.994 1,830.687 74.105 6.884
26 1995 1,058.285 1,892.016 75.193 6.851
27 1996 1,081.720 1,921.656 76.344 6.215
28 1997 1,103.199 1,957.405 77.961 5.640
29 1998 1,121.072 2,002.895 78.303 4.574
30 1999 1,155.906 2,045.234 79.049 4.491
31 2000 1,187.214 2,097.226 80.418 5.264
32 2001 1,227.448 2,157.280 81.755 4.797
33 2002 1,226.531 2,174.801 82.719 4.784
34 2003 1,250.078 2,189.106 83.683 4.071
35 2004 1,267.139 2,276.187 85.362 4.037
36 2005 1,292.436 2,307.203 86.793 3.354
37 2006 1,328.503 2,425.419 87.912 3.764
38 2007 1,350.414 2,535.845 90.618 4.217
39 2008 1,379.412 2,570.665 92.079 3.985
40 2009 1,380.452 2,500.874 92.452 3.222
41 2010 1,411.612 2,615.840 93.727 2.744
42 2011 1,463.357 2,762.535 95.811 2.609
43 2012 1,506.482 2,811.180 97.739 1.495
44 2013 1,535.283 2,876.449 99.045 1.571
45 2014 1,565.610 2,986.082 99.543 1.164

34
 46 2015 1,603.050 3,095.143 99.950 0.495
47 2016 1,650.402 3,212.504 100.983 0.092
48 2017 1,705.499 3,345.005 102.417 0.316
49 2018 1,756.367 3,476.173 104.451 0.396
50 2019 1,808.710 3,585.963 105.751 - 0.254
51 2020 1,709.438 3,461.285 105.484 - 0.511

2. Descriptive statistics using Stata

3. Estimation output – whole model

35
4. Estimation output – GNI on Consumption

5. Estimation output – Interest on Consumption

6. Estimation output – CPI on Consumption

36
 V. Declaration
I herewith formally declare that I myself have written the submitted paper
independently. I did not use any outside support except for the quoted literature and
other sources mentioned at the References of this work.

Hanoi, 6/10/2021 Ha, Nguyen

Ngoc

Hanoi, 6/10/2021 Schüler, Tobias

Hanoi, 6/10/2021 Weil, Kim Thao

37