Cointegration, Aggregate Consumption, and the Demand for Imports: A Structural Econometric Investigation

This paper uses a two-good version of the rational expectations permanent income model to derive a structural import demand equation for non-durable consumer goods. Under the identification restriction that taste shocks are stationary, the model is shown to imply that log imports, log domestic goods, and the log relative price of imports are co-integrated. The rational expectations permanent income hypothesis in conjunction with assumption of addilog (Houthakker (1960) ) preferences implies that the log of the demand for domestic goods is the correct "activity" variable on the right-hand-side of the import demand equation. This is because consumption of domestic goods is a noisy proxy for the unobservable utility index of permanent income, the marginal utility of wealth. Using the econometric approach suggested by Phillips-Loretan (1990), we estimate the co integrating vector and use these estimates to recover estimates of the utility parameters of the representative household. Given these utility parameters, we calculate expressions for the price and expenditure elasticities of import demand. The price elasticity of import demand is estimated to average 0.95 during the sample. The elasticity of import demand with respect to an increase in real spending is estimated to average 2.20. These estimates fall within the range reported in studies by Helkie and Hooper (1986), Cline (1989), and the many studies surveyed by Goldstein and Kahn (1985). The similarity between the OLS and Phillips-Loretan estimates of the parameters suggests that the simultaneous equation bias is not large.