The effect of interest rate on household consumption expenditure in South Africa

Abstract

The primary driver of the expansion of South Africa's Gross Domestic Product has been and continues to be household consumption. Conversely, interest rates have changed over time. These two economic indicators have the potential of determining the health of economy. Therefore, this study intends to reveal the effect of interest rate on household consumption expenditure in South Africa and ascertain the ways in which other carefully chosen explanatory either increase or decrease household consumption. This study absorbed a quantitative approach to analyse time series data over a 34-year period (1989 to 2022). The Autoregressive Distributed Lag (ARDL) bounds test was employed to test for the long run cointegrating relationship as well as to estimate the long run and short run models. The findings of the ARDL long run model indicate that household savings, interest rates, and inflation rates are inversely related to household consumption, while household disposable income, debt, and the real effective exchange rate are positively related to household consumption. The relationship between household debt, savings, and consumption is insignificant, nevertheless. The ARDL error correction model indicates that all variables are statistically significant in the short run, with household consumption being positively correlated with the interest rate, real effective exchange rate, and household disposable income, and negatively correlated with the inflation rate, household debt, and saving. According to the error correction model, each year, roughly 64% of the household consumption model's imbalances are resolved. Lastly, the VAR Granger causality test reveals a unidirectional association between household consumption and the real effective exchange rate, inflation rate, and household disposable income, while a bidirectional relationship exists between household consumption and the interest rate. Savings is the only variable that does not link with household consumption. The impulse response revealed that household consumption expenditure responds negatively to shocks in interest rate, inflation rate, and household saving. The response to shocks in family debt and the real effective exchange rate is initially positive but gradually declines until year 10. The variance decomposition results revealed that during the next ten years, all determinant factors had a stronger impact on changes in household consumption spending. Therefore, the policy recommendation is that the interest rate ought to be changed bySARB under an inflation targeting framework that takes inflation expectations into account. This strategy helps stabilise inflation expectations and offers a stable environment in which businesses and families can plan their investments and spending. The preservation of households' purchasing power through low and stable inflation promotes consumption.