SHORT TERM EFFECTS OF PERMANENT INCOME’S FACTORS OVER CONSUMPTION IN PAKISTAN (1976-2009)

This paper critically examines the short term effects of the permanent income over consumption as introduced by the Milton Friedman. The purpose of the present study is to explore the extent to which wealth indicators relating to permanent income can have an impact on consumption with respect to the income related indicators observed in Pakistan like gross value added, gross national expenditure, total reserves, natural resources and gross savings. The analysis of the consumption and income determinants has been carried out from 1976- 2009. An error correction model has been conducted to study this Permanent income phenomenon to observe the impacts of all these variables in short run. The research showed the results that the adjustment process is slow and short-term disequilibrium of previous period never adjusts completely in the current period. Short run adjustment pace of consumption is statistically significant, indicating that short run discrepancies do not adjust completely in the same period. Based on these evidences it is apparent that consumption and wealth variables are important to determine the macroeconomic stability in Pakistan. If the government gives priority to long-term consumption on the basis of exploring the available natural resources, it can gain better results in economic growth, poverty alleviation and unemployment reduction. The policy makers and economists in financial sector need to focus on the greater opportunities for wealth creation in the economy income hymen and the focus of this study is also on the effects of permanent income factors over consumption. A limitation of the research was the inclusion of only a limited number of wealth indicators.