AGGREGATE CONSUMPTION FUNCTION BASED ON KEYNES’ ABSOLUTE INCOME HYPOTHESIS: EVIDENCE FROM BANGLADESH

Abstract

This paper examines the short-term and long-term relationship between disposable income and consumption to evaluate the Keynesian absolute income hypothesis (AIH) for Bangladesh. Data from 1974 to 2021 were sourced from the WDI and the Policy Research Institute of Bangladesh. The OLS model, which segments the period into different parts as well as the entire timeframe, provides evidence supporting Keynesian AIH. Additionally, error correction models were used to analyze the relationship between disposable income and consumption. The negative and significant error correction coefficient indicates that the marginal propensity to consume (MPC) adjusts toward its long-run level even though it fluctuates in the short run. The pairwise Granger causality test was performed, and a bidirectional relationship between consumption and income was found. Various diagnostic tests were conducted to verify the robustness of the results, which strongly support the AIH for Bangladesh. Based on these findings, several policy recommendations are proposed for implementation by governments to help strengthen the economies of developing countries such as Bangladesh.