How Does the Sensitivity of Consumption to Income Vary Over Time? International Evidence

This paper studies how the sensitivity of consumption to income has changed over time
as the degree of financial integration has risen. In standard theory, greater financial
integration facilitates international borrowing and lending, helping to reduce the
sensitivity of consumption growth to fluctuations in income. We examine the empirical
validity of this prediction using an array of indicators of financial integration for a large
sample of advanced and developing countries over the period 1960-2011. We report two
main results. First, the sensitivity of consumption to income has declined over time as
the degree of financial integration has risen. The decline has been more pronounced in
advanced economies than in developing ones. Second, our regression analysis
indicates that a higher degree of financial integration is associated with a lower
sensitivity of consumption to income. This finding is robust to the use of a wide range of
empirical specifications, country-specific characteristics and other controls, such as
interest rates and outcome-based measures of financial integration. We also discuss
other potential sources of the temporal changes in the sensitivity of consumption to
income.