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Intergenerational Habits, Fiscal Policy, and Welfare

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  • Velculescu Delia

    (International Monetary Fund)

Abstract

The present paper explores the fiscal policy implications of intergenerational habit formation in a Blanchard overlapping generations small open economy model. Three main conclusions emerge. (1) When individuals are finitely lived and have habits which they pass on to their descendants, the dynamic response of a small open economy to shocks exhibits sluggishness in consumption in the short run and may display damped cycles in the long run. (2) With habits, optimal fiscal policy takes the form of a social insurance scheme, allowing present and unborn cohorts to share in the consequences of macroeconomic shocks. In contrast, in an economy devoid of habits, the optimal fiscal response to a permanent shock is a one time abrupt adjustment, whereby the present generations bear the entire burden of the shock. (3) If habits exist but policy is conducted as though habits did not exist, the welfare losses for society can be substantial.

Suggested Citation

  • Velculescu Delia, 2004. "Intergenerational Habits, Fiscal Policy, and Welfare," The B.E. Journal of Macroeconomics, De Gruyter, vol. 4(1), pages 1-34, September.
    • Handle: RePEc:bpj:bejmac:v:topics.4:y:2004:i:1:n:10
    DOI: 10.2202/1534-5998.1129
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    Cited by:

    1. Clinton, Kevin & Kumhof, Michael & Laxton, Douglas & Mursula, Susanna, 2011. "Deficit reduction: Short-term pain for long-term gain," European Economic Review, Elsevier, vol. 55(1), pages 118-139, January.
    2. Gabriel Fagan, 2007. "Adjusting to the Euro," Working Papers w200703, Banco de Portugal, Economics and Research Department.
    3. Ding, YingYing & Li, Zheng & Ge, Xiaojun & Hu, Yu, 2020. "Empirical analysis of the synergy of the three sectors’ development and labor employment," Technological Forecasting and Social Change, Elsevier, vol. 160(C).
    4. Velculescu, Delia, 2011. "Consumption habits in an overlapping-generations model," Economics Letters, Elsevier, vol. 111(2), pages 127-130, May.
    5. Mr. Jan-Peter Olters & Mr. Daniel Leigh, 2006. "Natural-Resource Depletion, Habit Formation, and Sustainable Fiscal Policy: Lessons from Gabon," IMF Working Papers 2006/193, International Monetary Fund.
    6. Kumhof, Michael & Laxton, Douglas & Leigh, Daniel, 2014. "To starve or not to starve the beast?," Journal of Macroeconomics, Elsevier, vol. 39(PA), pages 1-23.
    7. Mr. Jan-Peter Olters, 2007. "Old Curses, New Approaches? Fiscal Benchmarks for Oil-Producing Countries in Sub-Saharan Africa," IMF Working Papers 2007/107, International Monetary Fund.

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