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Deep or aggregate habit formation? Evidence from a new-Keynesian business cycle model

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  • Givens, Gregory

Abstract

Habit formation is a fixture of contemporary new-Keynesian models. The vast majority assume that agents form habits strictly over consumption of an aggregate good, leaving open the question of whether it might be preferable to have them form habits over differentiated products instead–an arrangement known as deep habits. I answer this question by estimating a model that nests both habit concepts as special cases. Estimates reveal that the data favor a specification in which consumption habits are stronger at the product level than at the aggregate level. A mix of significance tests and simulation results indicate that including deep habits greatly improves model fit, most notably with regard to inflation dynamics.

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Bibliographic Info

Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 45204.

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Date of creation: 25 Feb 2013
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Handle: RePEc:pra:mprapa:45204

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Keywords: Deep Habits; Nominal Rigidities; Inflation Persistence;

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  1. Jordi Galí & Pau Rabanal, 2004. "Technology Shocks and Aggregate Fluctuations," IMF Working Papers 04/234, International Monetary Fund.
  2. Emi Nakamura & Jón Steinsson, 2008. "Five Facts about Prices: A Reevaluation of Menu Cost Models," The Quarterly Journal of Economics, MIT Press, vol. 123(4), pages 1415-1464, November.
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  7. Nakamura, Emi & Steinsson, Jón, 2011. "Price setting in forward-looking customer markets," Journal of Monetary Economics, Elsevier, vol. 58(3), pages 220-233.
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  13. Frank Smets & Raf Wouters, 2007. "Shocks and Frictions in US Business Cycles : a Bayesian DSGE Approach," Working Paper Research 109, National Bank of Belgium.
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