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Deep Habits

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  • Morten Ravn
  • Stephanie Schmitt-Grohe
  • Martin Uribe

Abstract

This paper generalizes the standard habit formation model to an environment in which agents form habits over individual varieties of goods as opposed to over a composite consumption good. We refer to this preference specification as `deep habit formation'. Under deep habits, the demand function faced by individual producers depends on past sales. This feature is typically assumed ad-hoc in customer market and brand switching cost models. A central result of the paper is that deep habits give rise to countercyclical markups, which is in line with the empirical evidence. This result is important because ad-hoc formulations of customer-market and switching-cost models have been criticized for implying procyclical and hence counterfactual markup movements. The paper also provides econometric estimates of the parameters pertaining to the deep habit model.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 10261.

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Date of creation: Feb 2004
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Publication status: published as Ravn, Morten, Stephenaie Schmitt-Grohe and Martin Uribe. "Deep Habits," Review of Economic Studies, 2006, v73(1,Jan), 195-218.
Handle: RePEc:nbr:nberwo:10261

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  1. Cochrane, John H. & Campbell, John, 1999. "By Force of Habit: A Consumption-Based Explanation of Aggregate Stock Market Behavior," Scholarly Articles 3119444, Harvard University Department of Economics.
  2. Heaton, John, 1995. "An Empirical Investigation of Asset Pricing with Temporally Dependent Preference Specifications," Econometrica, Econometric Society, Econometric Society, vol. 63(3), pages 681-717, May.
  3. Andrew B. Abel & Avinash Dixit & Janice C. Eberly & Robert S. Pindyck, 1996. "Options, the Value of Capital, and Investment," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 111(3), pages 753-77, August.
  4. Braun, Phillip A. & Constantinides, George M. & Ferson, Wayne E., 1993. "Time nonseparability in aggregate consumption : International evidence," European Economic Review, Elsevier, Elsevier, vol. 37(5), pages 897-920, June.
  5. Edward C. Prescott, 1986. "Theory ahead of business cycle measurement," Staff Report, Federal Reserve Bank of Minneapolis 102, Federal Reserve Bank of Minneapolis.
  6. Morten Ravn & Stephanie Schmitt-Grohé & Mart�n Uribe, 2006. "Deep Habits," Review of Economic Studies, Oxford University Press, vol. 73(1), pages 195-218.
  7. Rotemberg, Julio J & Saloner, Garth, 1986. "A Supergame-Theoretic Model of Price Wars during Booms," American Economic Review, American Economic Association, American Economic Association, vol. 76(3), pages 390-407, June.
  8. Gali Jordi, 1994. "Monopolistic Competition, Business Cycles, and the Composition of Aggregate Demand," Journal of Economic Theory, Elsevier, Elsevier, vol. 63(1), pages 73-96, June.
  9. Yun, Tack, 1996. "Nominal price rigidity, money supply endogeneity, and business cycles," Journal of Monetary Economics, Elsevier, Elsevier, vol. 37(2-3), pages 345-370, April.
  10. Bils, Mark, 1989. "Pricing in a Customer Market," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 104(4), pages 699-718, November.
  11. Rotemberg, Julio J & Woodford, Michael, 1992. "Oligopolistic Pricing and the Effects of Aggregate Demand on Economic Activity," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 100(6), pages 1153-1207, December.
  12. Klemperer, Paul, 1995. "Competition When Consumers Have Switching Costs: An Overview with Applications to Industrial Organization, Macroeconomics, and International Trade," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 62(4), pages 515-39, October.
  13. Wayne E. Ferson & George M. Constantinides, 1991. "Habit Persistence and Durability in Aggregate Consumption: Empirical Tests," NBER Working Papers 3631, National Bureau of Economic Research, Inc.
  14. Thomas D. Tallarini, Jr. & Harold H. Zhang, 2005. "External Habit and the Cyclicality of Expected Stock Returns," The Journal of Business, University of Chicago Press, University of Chicago Press, vol. 78(3), pages 1023-1048, May.
  15. Julio J. Rotemberg & Michael Woodford, 1993. "Dynamic General Equilibrium Models with Imperfectly Competitive Product Markets," NBER Working Papers 4502, National Bureau of Economic Research, Inc.
  16. John Y. Campbell & John Cochrane, 1999. "Force of Habit: A Consumption-Based Explanation of Aggregate Stock Market Behavior," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 107(2), pages 205-251, April.
  17. Marc Giannoni & Michael Woodford, 2004. "Optimal Inflation-Targeting Rules," NBER Chapters, in: The Inflation-Targeting Debate, pages 93-172 National Bureau of Economic Research, Inc.
  18. Andrew B. Abel, 1990. "Asset Prices under Habit Formation and Catching up with the Joneses," NBER Working Papers 3279, National Bureau of Economic Research, Inc.
  19. Jeffrey C. Fuhrer, 2000. "Habit Formation in Consumption and Its Implications for Monetary-Policy Models," American Economic Review, American Economic Association, American Economic Association, vol. 90(3), pages 367-390, June.
  20. Constantinides, George M, 1990. "Habit Formation: A Resolution of the Equity Premium Puzzle," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 98(3), pages 519-43, June.
  21. Julio J. Rotemberg & Michael Woodford, 1991. "Markups and the Business Cycle," NBER Chapters, in: NBER Macroeconomics Annual 1991, Volume 6, pages 63-140 National Bureau of Economic Research, Inc.
  22. Dunn, Kenneth B. & Singleton, Kenneth J., 1986. "Modeling the term structure of interest rates under non-separable utility and durability of goods," Journal of Financial Economics, Elsevier, Elsevier, vol. 17(1), pages 27-55, September.
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