A major difficulty in estimating consumption functions when prices are not fixed is the perverse effect of inflation on private consumption behaviour. This paper examines an Euler equation-type consumption function to analyse consumption behaviour in a context of persistent high inflation. The paper examines how widespread backward-looking indexation and/or partial or total currency substitution in the case of dollarisation affect private consumption behaviour. Widespread indexation and/or dollarisation are expected to create a type of insurance against adverse investment outcomes. This leads to ex post efficient risk allocation and provides an important mechanism for smoothing consumption in the presence of uninsurable income shocks, such as inflation surprises. Latin American data is used in this paper due to the recent history of chronic inflation in the region.
consumption; inflation; indexation; currency substitution
