Publications   Empirical StudiesKYN - SLAMA: MACROECONOMIC CONSUMPTION FUNCTION FOR CZECHOSLOVAKIA

A. Introduction

1

Until recently the consumption function had played next to no role in Soviet-type macroeconomics and had rarely been estimated. The apparent reason for this neglect was the generally accepted view that the centrally planned economies were supply rather than demand-oriented and that, therefore, capacity constraints, as represented by the production function, for example, were much more important for explaining the level of economic activity than any of the elements of aggregate demand.

This may very well be true, although aggregate output is not determined by capacity alone, as is obvious from the fact that considerable fluctuations in the degree of utilization of factors of production can be observed in all centrally planned economies1. Such fluctuations are, however, hardly caused by changes in aggregate demand. The Keynesian multiplier cannot really work in an economy in which the activities of producers depend on centrally prescribed targets rather than on decentralized market signals.

Around the beginning of the nineteen-seventies the situation changed dramatically and empirical estimates of macroeconomic consumption functions for the Soviet Union, Czechoslovakia, Poland, Hungary and East Germany began to appear one after the other. Most of them were just parts of econometric models of the respective countries2, although a few independent studies of consumption and saving behavior also appeared3.

2

Some of the estimated consumption functions were demand-oriented and, like the consumption functions for the market economies, were supposed to model consumers' behavior. Others considered aggregate consumption to be determined by the supply of consumer goods. Still others tried to incorporate both the demand and supply sides into the model

It is not our purpose here to review already estimated consumption functions but to look at the question of whether it is at all meaningful to formulate and estimate macroeconomic consumption functions for Soviet-type economies and whether such functions would represent the behavior of consumers, of planners, or of both. The theoretical deductions will be supported by empirical estimates for Czechoslovakia, which are, alas, only fragmentary.

To contrast the macro-determination of consumption in Soviet-type and market economies, we shall present first a highly simplified version of the familiar Keynesian model.

3

The aggregate demand for final goods Z (intermediate goods are excluded from the analysis) consists of the final demand for consumer goods C, investment I, and government purchases G.

(1)

Z = C + I + G

The demand for consumer goods is a (linear) function of disposable income YD.

(2)

C = ao + a1 YD

4

The demand for investment goods depends on aggregate income Y and on the interest rate r.

(3)

 I = I (Y, r)

The aggregate final product Y, (which is by definition equal to aggregate income) is in equilibrium equal to aggregate demand.

(4)

 Y = Z

5

Finally, disposable income is equal to aggregate income minus taxes T, which again depend on income.

(5)

YD = Y - T (Y)

The structure of this model clearly reflects the institutional setup and operational features of a market economy. The primary role of demand in the determination of the level of economic activity can be seen from the fact that capacity constraints do not even appear. The crucial equilibrium condition (4), which is usually omitted, makes sense only if production adjusts practically instantaneously to demand, as is the case in a well functioning market economy.

6

The three most crucial components determining the aggregate demand and therefore also the level of economic activity are

(i) consumer behavior modeled by the consumption function (2)

(ii) entrepreneurial behavior modeled by the investment function (3)

(iii) governmental fiscal policy (the monetary sector was excluded for the sake of simplicity) which determines government expenditures G and tax rates, i.e. the function T(Y).

The importance of the assumption of a well functioning market, which justifies the validity of the equilibrium condition (4), cannot be overemphasized. If, for example, aggregate consumption were constrained by the supply of consumer goods rather than by demand, then empirical estimates obtained by regressing the observed consumption expenditures on the observed disposable income would not properly represent consumer behavior.

7

It is quite obvious that the model described above cannot account adequately for a Soviet-type economy, where planners set production targets, allocate resources, and fix prices and wages, and where market forces cannot exert their spontaneous equilibrating function.

 Because consumers obviously cannot consume what has not been produce and the output of consumer goods is clearly determined by planners, it can be argued that the macroeconomic consumption function in the Soviet-type economy would represent the planners' rather than the consumers' behavior. On the other hand, consumer goods are not rationed - at least not in the recent form of the Soviet-type economy – so that the individual consumer is free to spend his disposable income as he wishes and particularly he cannot be forced to consume what he does not want. This may imply that the macroeconomic consumption function could represent the behavior of consumers in dividing their disposable income between consumption expenditures and saving as it does in market economies.

8

As we shall see, these two seemingly contradictory views can be reconciled, if the model is made to contain two behavioral equations rather than one.

The first equation, which can be conveniently named "the planners' consumption function'', would model the determination of the supply of consumer goods, while the second equation, or "the consumers’ consumption function", would model the demand for consumer goods. The place of these two equations in the overall model can be seen from the following exposition.4

In their attempt to coordinate the economy, planners use a complex system of partial (individual) and aggregate (synthetic) balance sheets. We shall describe them in a simplified way, using the familiar input-output notation.

9

The interrelated system of material balance sheets for individual products can be described by the following input-output equation

(6)

q = Aq + c + i + g

where 
A

is a matrix of planned norms of technological consumption (input-output coefficients)

q

 is a vector of output targets for the production of individual goods

c

 is a vector of targets for the supply of consumer goods

i

is a vector of targets for the supply of investment goods

g

 is a vector of targets for the supply of other final products.

10

Given the technologically determined5 matrix A, planners must simultaneously determine vectors q, c, i, and g in such a way that the balance conditions (6) are met.

 

 

 

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