Consumption, credit constraints, and financial liberalization: Evidence from Taiwan

This paper employs the data from the Survey of Family Income and Expenditure in Taiwanto empirically explore the role of credit constraint in Taiwan’s household consumption. In early 1990s, the Taiwan government enacted policies of financial market deregulation, which included the granting of new licenses to commercial banks. As a result, fifteen new banks were founded in 1991 alone. The liberalization of the credit market as such should theoretically have a profound impact on credit constraints faced by Taiwan’s households and, as a result, their consumption.

Since few studies have explored in detail the effect of the above-mentioned early 1990s financial deregulation on Taiwan’s household consumption, we employ 1981-2013 data from the Survey of Family Income and Expenditure in Taiwan to explore the issue. In particular, we construct household cohorts’ data on consumption and income according to the birth year of household head using the pseudo-panel approach of Deaton (1985). We then use the constructed cohorts’ data to explore whether the evidence for credit constraint exists and how the degree of credit constraint faced by these cohorts changed over the event of the early 1990s financial deregulation. We also use cohorts’ net income from wealth as a percentage of total income as a proxy to differentiate the degree of credit constraint faced by the cohorts. We explore how the consumption behavior of different cohorts with differing degrees of credit constraints would change over the event of early 1990s financial deregulation. This paper also examines how the young (with age below 40) and old generations (with age above 40), presumably facing different degree of credit constraint, would react differently to the early 1990s financial deregulation in their consumption decision. We find that the sensitivity of consumption to income, evidence for the existence of credit constraint, tends to be lower for post financial reform and the changes in sensitivity are more prominent with higher credit constraint.