Determinants of real private consumption expenditure in Lesotho

Abstract

Using the Autoregressive Distributed Lag (ARDL) approach to cointegration, an error correction model (ECM) is estimated for real private domestic consumption in Lesotho. Lesotho is one of a number of countries with low gross domestic product (GDP) per capita, that are landlocked and of which the national currency is pegged to that of a highly dominant trading partner. Analysis of consumption pattern in such countries is scant in the literature. This paper finds evidence of a long-run relationship between private consumption, income, interest rates, and inflation. The empirical findings suggest that higher income is associated with higher private consumption, higher inflation reduces private consumption and that higher interest rates reduce private consumption, implying that the substitution effect outweighs the income effect in Lesotho in the long term. Although the model is not designed to evaluate consumption theories, the estimated parameters to some extent support the absolute income hypothesis (AIH), relative income hypothesis (RIH), life-cycle hypothesis (LCH) and permanent income hypothesis (PIH).