Effect of Interest Rate on Consumption under Alternative Expectations Hypotheses: Evidence from Pakistan

Abstract

Estimation results from the adaptive expectations PIH and rational expectations RWH consumption functions indicate that the real interest rate or expected inflation rate has no effect on consumption behavior in Pakistan. Consequently, individuals do not alter significantly their projected consumption path in response to higher rates of return on savings. A likely outcome of such insensitivity is a current account deficit due to the low income and savings ratio and limited domestic capital formation.