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Keeping up with the Joneses, reference dependence, and equilibrium indeterminacy

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  • Stracca, Livio
  • al-Nowaihi, Ali

Abstract

This model extends the keeping up with the Joneses (KUJ) model to incorporate the notion that positional concerns in consumption are best modelled with a reference dependence specification of preferences, as postulated by Tversky and Kahneman (1991) in the context of riskless choice. In line with this specification, which has received substantial empirical support in the literature, we assume that the marginal returns on the own consumption are increasing below the aggregate per capita levels of consumption (which is the reference point in our model). The main conclusion of the paper is that in our KUJ model aggregate consumption may be subject to sunspot fluctuations and the equilibrium level of consumption is not uniquely pinned down. The paper also discusses the role that fiscal policy can play in order to undo the effect of consumption externalities on both the determinacy and the desirability of the equilibrium. JEL Classification: D11, H21

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Bibliographic Info

Paper provided by European Central Bank in its series Working Paper Series with number 0444.

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Date of creation: Feb 2005
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Handle: RePEc:ecb:ecbwps:20050444

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Related research

Keywords: Consumption externalities; equilibrium indeterminacy; keeping up with the Joneses; optimal taxation; reference dependence;

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  1. Jang-Ting Guo & Kevin J. Lansing, 1997. "Indeterminacy and stabilization policy," Working Paper 9708, Federal Reserve Bank of Cleveland.
  2. Falk, Armin & Knell, Markus, 2004. "Choosing the Joneses: Endogenous Goals and Reference Standards," CEPR Discussion Papers 4459, C.E.P.R. Discussion Papers.
  3. Botond Koszegi & Matthew Rabin, 2005. "A Model of Reference-Dependent Preferences," Levine's Bibliography 784828000000000341, UCLA Department of Economics.
  4. Roger E. A. Farmer, 1999. "Macroeconomics of Self-fulfilling Prophecies, 2nd Edition," MIT Press Books, The MIT Press, edition 2, volume 1, number 0262062038, December.
  5. Jaime Alonso-Carrera & Jordi Caballé & Xavier Raurich, 2004. "Consumption Externalities, Habit Formation and Equilibrium Efficiency," Scandinavian Journal of Economics, Wiley Blackwell, vol. 106(2), pages 231-251, 06.
  6. Easterlin, Richard A., 1995. "Will raising the incomes of all increase the happiness of all?," Journal of Economic Behavior & Organization, Elsevier, vol. 27(1), pages 35-47, June.
  7. Benhabib Jess & Farmer Roger E. A., 1994. "Indeterminacy and Increasing Returns," Journal of Economic Theory, Elsevier, vol. 63(1), pages 19-41, June.
  8. Clark, Andrew E. & Oswald, Andrew J., 1996. "Satisfaction and comparison income," Journal of Public Economics, Elsevier, vol. 61(3), pages 359-381, September.
  9. Gali, J., 1992. "Keeping Up with the Joneses: Consumption Externalities, Portfolio Choice and Asset Prices," Papers 92-22, Columbia - Graduate School of Business.
  10. Harald Uhlig & Lars Ljungqvist, 2000. "Tax Policy and Aggregate Demand Management under Catching Up with the Joneses," American Economic Review, American Economic Association, vol. 90(3), pages 356-366, June.
  11. Christiano, Lawrence J. & G. Harrison, Sharon, 1999. "Chaos, sunspots and automatic stabilizers," Journal of Monetary Economics, Elsevier, vol. 44(1), pages 3-31, August.
  12. David Bowman & Deborah Minehart & Matthew Rabin, 1994. "Loss aversion in a consumption/savings model," International Finance Discussion Papers 492, Board of Governors of the Federal Reserve System (U.S.).
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