In August 2010, the Department of Commerce reported that economic weakness continues across the country, with consumer spending continuing to stagnate. The government is considering various tax benefits to stimulate consumer spending through increased disposable income. The consumption function is one of the key relationships in economics, where consumption (y ) depends on disposable income (x). Consider the following table, which presents a portion of quarterly data on disposable income and personal consumption expenditure for the U.S. Both variables are measured in billions of dollars and are seasonally adjusted. The full data set is on the text website, labeled Income and Consumption.
a. Plot the consumption series. Estimate the appropriate polynomial trend model to forecast consumption expenditure for the 1st quarter of 2011.
b. Estimate yt = β0 + β1xt - 1+ ε t to forecast consumption expenditure for the 1st quarter of 2011.
c. Which of these two models is more appropriate for making forecasts? Explain.