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 quarterly data for these seasonally adjusted variables, measured in billions of dollars. A portion of the data is shown in the accompanying table; the complete data set is on the text website, labeled Consumption Quarterly.
a. Estimate Consumption = β0 + β1 Disposable Income + ε. Plot the residuals against time to determine if there is a possibility of serial correlation.
b. Discuss the consequences of serial correlation and suggest a possible remedy.